Margin equity requirements
Trading on margin involves additional risks and complex rules, so it's critical that you understand the requirements and industry regulations before placing any trades. When you trade on margin, you are essentially borrowing against the value of your securities in an effort to leverage your returns.
To remain in the good graces of your brokerage firm, you must meet and maintain certain equity levels, including initial and "house" margin requirements. Most brokerage firms maintain house margin requirements that exceed the minimum equity requirements set forth by regulators. For more on this topic, please read Meeting the requirements for margin trading.
If the equity in your margin account falls below your firm's house requirements, most brokerage firms will issue a margin call. When this happens, you will need to take immediate action to increase the equity in your account by depositing cash or marginable securities, or by selling securities. If you fail to act promptly, your broker may go ahead and liquidate shares in your account without any advance notification. In fact, your broker can liquidate your margin account holdings without even issuing a margin call. For this reason, you should monitor the equity levels in your margin account closely to avoid unanticipated liquidations.
Along with strict equity requirements, margin accounts impose additional trading rules that you need to understand to avoid violations. Let's examine one of the more common margin trading violations you should understand in more detail.
What is it? A margin liquidation violation occurs when your margin account has been issued both a Fed and an exchange call and you sell securities instead of depositing cash to cover the calls.
If you are an intraday trader and you sell positions you opened during the same day, you will not incur a margin liquidation violation. If you open a position that creates and exceeds your intraday or margin buying power and hold the position overnight, your account could be in a Fed and exchange call (as well as a house call). Selling your position the following business day would create a margin liquidation violation.
The following example illustrates how Justin, a hypothetical intraday trader, might incur a margin liquidation violation:
Margin liquidation example – Justin:
- Intraday buying power = $100,000.
- Today, Justin buys $100,000 of ABC stock. He reviews his margin account balances and understands that he is very close to being in an exchange call, but is not overly concerned because he is planning on selling the stock before the market closes today.
- Later in the day, the price of ABC stock declines and Justin realizes that if he sells his shares he will incur a loss. He decides to hold the shares overnight and hope for the price to rise the next day.
- At the end of the day, Justin reviews his margin account balances again and finds that he is in both a Fed call and an exchange call.
- The following day, Justin decides to sell his ABC stock to cover the calls.
Justin would incur a margin liquidation violation because he was in a Fed and exchange call at the same time and liquidated the position that caused the calls.
Consequences: If you incur 3 margin liquidation violations in a rolling 12-month period, your account will be limited to margin trades that can be supported by the SMA (Fed surplus) within the account. This restriction will remain in place for 90 calendar days, or one year from the first liquidation, whichever is longer.
As this example illustrates, it's easy to encounter problems if you are an active trader and don't fully understand margin account trading rules and how to decipher your margin account balances. That's why it is important to review these rules prior to opening a new position in your margin account. See where you can find account specific details on Fidelity.com to help monitor your margin account
