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Margin Call
A Margin call is a forced closing of a trade due to a lack of personal funds to secure it.
Emergence of the margin call
The first trading exchanges arose in the XII-XV centuries in Venice, Genoa and Florence. The first stock exchange was established in London at the end of the 17th century. Back then, deals were made in a large common room with a hundred people present. The auction would be won by the participant who shouted out the best price the loudest.
At that time, they only traded on their own, and no one knew the notion of ‘what is a margin call’
One hundred years ago, the opening and closing of positions on the stock exchange was already carried out by phone. The trader would call his broker and give instructions to buy or sell an asset using his own funds on deposit.
In the US and Europe such trading platforms are still operating now. You can have an idea the way it looks like from the movie “The Wolf of Wall Street” or reality television series “Million Dollar Traders”
If the market changed direction, and the price dynamics led to a decrease in funds in the trading account, the broker would call the trader with a demand to increase the size of the deposit – margin. Thus, it was called a Margin Call.. If the trader did not have time to quickly replenish the deposit, his unprofitable positions were forcibly closed.
Nowadays, trading on the stock exchange is carried out mainly via the Internet. But the situation when the loss from a trading transaction can exceed the size of the deposit is still called a margin call, in the good old fashioned way.
How one gets into a margin call. Example
This situation is always associated with margin trading, when a trader uses a loan to increase profits. A loan being issued is secured by a deposit and can increase not only profits, but also losses.
To ensure that losses do not exceed the agreed percentage of the margin, an automatic exit from an open position is provided. Often the amount of losses is limited between 95% – 98% of the deposit.
The platform system keeps track of the difference between the balance on the trading account and the amount of loss. If it approaches the given level, the trader gets into a margin call. The borrowed funds are returned to the lender. The losses are deducted from the remaining amount of the deposit and the commissions of the exchange for opening and closing the order are withheld.
What are margin calls is well known to short sellers and scalpers. Long sellers, though, may never get to discover them.
