There are two limitations on the borrowing amount from your forex broker. The first is the initial margin that can have as a loan from your foreign exchange brokerage firm or from an individual broker. The second restriction is the maintenance margin which is the sum you have to maintain in your margin account subsequent to you trade forex. These restrictions are fixed by your foreign exchange broker and the Federal Reserve Board. However, the Federal Reserve Board fixes an initial margin of 50 percent as a minimum and a maintenance margin of 25 percent as a minimum in the margin account. In volatile forexmarkets, prices can drop very rapidly. If the equity in your margin account is less than the maintenance margin, the forex brokerage firm or an individual broker will issue you a “margin call”. A margin call compels you to either liquidate your position in the stock or deposit more money in the margin account.
Working mechanism of a margin call in forex
The working mechanism of a margin call in foreign exchange can be understood with a simple example. You assume that you buy securities of worth $30,000 by having a loan of $15,000 from your forex brokerage firm and paying $15,000 yourself. If the market worth of the securities falls by $25,000, the equity in your margin account drops by $10,000 ($25,000 – $15,000 = $10,000). Presuming a maintenance requirement of 25%, you must have $6,250 in equity in your account (25% of $25,000 = $6,250). Thus, you are comfortable with this condition as the $10,000 worth of equity in your account is greater than the maintenance margin of $6,250. But, you assume that the maintenance obligation of your brokerage firm is 45% instead of 25%. In this case, your equity of $10,000 is less than the maintenance margin of $11,250 (45% of $25,000 = $11,250). Consequently, the brokerage firm may issue you a margin call.
Situations when failed to meet the margin call
If for any cause you do not fulfill the margin call, the brokerage firm has the power to put up your securities for sale to boost your margin account equity pending you are more than the account’s maintenance margin. Even the scaring feature of the margin call is the fact that your brokerage firm has no necessity to discuss with you prior to selling. According to most margin accords, a brokerage firm can sell your securities without waiting for you to meet the margin call. You cannot even control which stock is sold to compensate the margin call. Due to this, it is essential that you read the margin agreement of your brokerage firm with the utmost care earlier than investing. This accord explains the stipulations of the margin account, containing: the way the interest is computed, your tasks for repaying the credit and the way the securities you buy serve as a security for the credit.
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