In investing terms, the margin is the money borrowed by the investors for making an investment or transaction. Particularly in stock and derivative markets, the investors utilize leverage allowed by the broker and clearing houses. These clearing houses and brokers require investors to maintain a certain minimum balance in their margin accounts.
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What is the Maintenance Margin?
Maintenance Margin is the minimum required balance an investor must keep in the margin account after any transaction takes place.
The concept of margin account works closely as of leverage allowed by the brokers. In Forex trading, the use of leverage is normal. Similarly, in stock trading and derivatives, the need for margin is imminent. Margin accounts work well for traders looking for short-selling and making full use of scalping strategies. Brokers adjust the margin calls by the end of the trading day for investors. Any amounts over or below the maintenance margin adjusted are called variation margin deposits.
Margin deposits work as collateral with the brokers. There are three types of margin deposits, frequently these margins are initial margin and maintenance margin.
Maintenance Margin Vs Initial Margin- The Difference
Investors trading on margin accounts need to put the money in a brokerage account with a preset initial requirement level. This is the initial margin that is represented usually in a percentage of the total account limit. The regulatory authorities set the initial margin requirements, usually the Financial Industry Regulatory authority (FINRA) in the US. The current regulation calls for an initial cash deposit of $2,000. And the initial margin of 50% for the total transaction value. It means brokers allow leverage of 50% on margin accounts on stock trades.
Suppose an investor opens a margin account with a broker. The investor wishes to buy 1,000 stocks of a company valued at $15.00. The broker will require the investor to initially depositing an amount of $7,500 (50% of the total $15,000). Brokers allow the leverage to make a commission on several trades. The investors can then cover the excessive leverage by shorting or selling the stocks later.
If the investors’ trade volume is high, the transaction leverage may rise above the initial margin held with the broker. Brokers require an additional cushion of security with large trades. Therefore, they set a minimum requirement of the margin account balance to be maintained at all times. We commonly call that threshold amount as the maintenance margin. The current requirement set by FINRA is 25% for stock traders.
The Regulatory authorities only set a directional rule for both initial margin and maintenance margin. Brokers and clearing house set their limits or percentage figures. Usually, brokers would require a higher maintenance margin than 25%. In particular, its requirements will be higher for retail investors.
How Maintenance Margin is Determined
The minimum deposit in a margin account can be different for different brokers. A minimum of 25% maintenance margin is a threshold regulatory requirement. The requirement varies with a change in the stocks held by the investor.
For example, an investor holds 100 shares of ABC Inc. at a current price of $27.8. If the investor opened the account with a 50% initial margin, the balance in the margin account would be $1,390 minimum. The 25% maintenance margin requires maintaining a threshold amount of $695. If the stock price decreases considerably to $13.0, the margin account balance will drop to $650. The investor will have to deposit an additional $45 to maintain the original maintenance margin.
The initial margin remains tied with stock or any financial instrument price. As the stock prices fluctuate the initial margin requirement changes. The Maintenance margin closer to 50% of the initial margin will vary quickly as it will shrink the difference.
How does Maintenance Margin work?
The value of the margin account remains the total value of the stocks held by an investor. As the investors make a trade on leverage, they must return the leveraged amount to the brokers. Most brokers keep an initial margin as a fixed minimum deposit. The FINRA requires a minimum of $2,000 in cash or securities. However, the brokers demand a significantly higher amount than only $2,000. As most traders look for frequent trading strategies such as shorting or scalping, they need to maintain an average balance in the margin account.
Brokers keep the maintenance margins ratios high up to 40% or 50% of the total trade value. If the margin account balance falls below the maintenance margin, brokers make a margin call. Brokers can close the deal with a margin call recovering the required balance and commission.
Investors can make high profits with leverage allowed by the brokers. An investor with short-selling can still repay the loan and commission with a low initial investment and a maintenance margin.
With our example, suppose the share prices rise by 25% to $34.75. The investor decides to make a profit by selling all 100 shares held. The broker will retain the initial leverage of 50% (on original share price offered), which amounted to $ 1,390. The investor can still make a net profit of $695 with an initial investment of $1,390. Assuming the trade takes place on the same day, avoiding any interest charges. The commission on both call and put will have to be adjusted.
A fall or increase of a double-digit percentage in shares under a normal trading day is highly unlikely. However, the concept of maintenance margin offers collateral to the brokers and the clearing houses. It becomes significantly important with high leverage derivatives such as Futures and Options. In Forex, the leverage of 1:50 or 1:100 is normal. Under these conditions, it provides an additional layer of protection to the brokers.
Pros and Cons of Maintenance Margin
Margin accounts provide additional leverage for the investors. Unlike cash accounts, investors can trade for securities valued higher than the initial deposits. Margin accounts are common among the day traders. However, to secure the balance and keep the transaction margins in check, both initial and maintenance margins play pivotal roles.
Investors can enjoy high leverage against initial and maintenance margins. It may also lure them to make risky trades. For brokers, it offers them a level of security as collateral to recover commission, interest, and difference on trade values in case of losses.
A Quick Wrap-Up
The Maintenance margin is the threshold amount that brokers require to maintain in the margin account. It is usually set by the Federal Regulators of the country described in the percentage terms. Brokers and clearing houses may require significantly higher maintenance margins close to the initial margin ratio of 50%.
