What is a Margin Call?
A margin call is a demand from an asset lender to increase the amount of assets held as collateral in a trading account using borrowed funds, also known as a margin account. Margin calls are issued following price movement against a trader’s margined positions that the lender considers significant enough to put the recovery of their margin loan capital at risk.
Crypto traders looking to maximize their potential returns are able to borrow funds from certain exchanges and combine them with their own assets. Also known as leverage trading, margin allows traders to place much larger trades than would otherwise be possible without these borrowed funds.
Margin trading has risks – especially given the highly volatile nature of crypto markets. One of them is receiving the urgent demand for additional collateral known as a “margin call.”
What Triggers a Margin Call?
A margin call is triggered when an investor's margin collateral falls below a certain level or percentage requirement required by an exchange. This level is referred to as maintenance margin.
A margin call is issued when one or more of the open positions in a margin account has decreased in value. If a trader’s positions are significantly leveraged (comprised of several times more borrowed money than his or her own money), a margin call can be triggered by a relatively small percentage decline.
If a trader is unable to meet the requirements of the margin call, the lender will close the trader’s open positions through a process known as “liquidation” and take possession of the resulting cash balance to cover the margin call.
How Does a Margin Call Work?
One of the most important things to understand about margin calls is that your open positions can be sold by the lender without your real-time consent.
This is a condition you will have to agree to when you sign up for a margin loan. The lender has ultimate power over when you are required to increase the equity in your margin account and can sell your assets in order to cover shortfalls.
Most exchanges automatically prompt investors to add additional funds via email, but they are not always obligated to do so. Whether you receive a margin call notification or not, an exchange can take immediate action to close your open positions in the event maintenance margin falls below the minimum required, regardless of the cost to the investor.
An exchange can opt to close all open positions or just enough to cover the margin call.
In the latter scenario, positions are typically closed based on a first in, first out (FIFO) basis. This means if you have profitable positions that were opened before losing trades, those profitable positions will be at risk of liquidation first.
In addition, liquidations are executed at the best possible market price, without regard for how low that price might be. This can often extend losses if market conditions are particularly volatile or large open positions are sold into an illiquid market.
How Do You Calculate Margin Level?
Maintenance margin, or “margin level” on some trading platforms like Kraken, is the percentage-based ratio of your account equity to the amount used to open margin positions.
Equity is the sum of your collateral holdings plus or minus any unrealized profit or loss on open positions.
- Equity = (value of collateral holdings - borrowed funds)
Used margin is the amount of funds required to open a margin position. The total trade amount divided by the leverage level used to open the trade produces the used margin amount. For example, if a $1,000 position is opened using 2x leverage, the used margin is $500.
For long positions, the following equations can be used to identify how much assets can fall before reaching minimum maintenance margin (usually set at 80% at Kraken) and liquidation level (40% at Kraken):
- Margin Call Price = Entry Price - ((Equity - (Used Margin x 0.8)) / Open Volume)
- Liquidation Price = Entry Price - ((Equity - (Used Margin x 0.4)) / Open Volume)
For short positions, a separate set of equations is used to determine maintenance margin and liquidation levels. This is because the quote currency (cash or stablecoin) is used for long margin positions, while the base currency (BTC, ETH, etc,) is used for short margin positions.
Because the cash-denominated value of the base currency fluctuates (e.g., the USD-denominated value of BTC is constantly changing), a different calculation must be done.
- Margin Call Price = Leverage x (Trade Balance + (Entry Price x Open Volume)) / (Open Volume x (0.8 + Leverage))
- Liquidation Price = Leverage x (Trade Balance + (Entry Price x Open Volume)) / (Open Volume x (0.4 + Leverage))
How to Avoid a Margin Call
It is important to understand what triggers a margin call and what steps can be taken to minimize the risk of a forced margin sell by the lender.
When an investor uses an asset that they own as collateral for a leveraged position, the value of their collateral fluctuates as that asset price rises or falls. If the equity in their account falls below the broker's required maintenance margin amount, a margin call may be issued.
The same applies for investors using cryptocurrency as collateral. Sharp changes to the fiat-denominated value of open crypto positions can quickly trigger margin calls if the value of funds held in the margin account falls below maintenance margin.
The following considerations and strategies can help minimize the odds of a margin call:
Prepare for volatility: Leaving a considerable funding cushion in a margin account can help protect investors from a sudden drop in the value of their loan collateral. Keeping additional liquid resources at the ready in case they are needed to restore minimum required margin maintenance can help avoid a forced liquidation.
Set a personal trigger point: Traders may use stop loss orders to manage risk, choosing to close their margin positions well before the risk of a margin call becomes a concern. This approach allows a trader to sell in a more orderly and price-sensitive manner than a margin call’s market-order forced liquidations generally provide.
Monitoring: In addition to actively monitoring their accounts, investors may also use alerts to notify them when the value of their open positions declines to certain levels.
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Summary of a Margin Call
- A margin call may occur when the equity in an investor’s margin account falls below the collateral maintenance level required by an exchange. Collateral is the funds and assets an investor must hold in their account to secure a margin loan.
- Once a margin call has been issued, an investor must either deposit new funds and/or close their open positions so that minimum margin collateral is restored.
- Exchanges may liquidate a trader’s open positions at any time and at their sole discretion, regardless of market price, if a margin call is not met quickly by other means.