A margin call is defined as a request from the broker to the investor to deposit more money or reduce open positions because their equity is not sufficient to cover the required margin for their open positions.
To understand what a margin call is, we need to understand margin first.
Margin trading allows you to trade more money than what you really have. Your broker allows you to open positions of the size you choose by depositing only a percentage of the total size of the deal as collateral. This collateral is called margin.
Another important definition that we need to familiarize ourselves with in order to fully understand the concept of margin call is equity.
The account equity is the current value of all the assets within it. Simply put, equity is the total of the current cash balance of the account and unrealized profit/loss.
For example, if an investor deposits USD 10,000 and then buys one gold contract, and the profit on this contract reaches USD 2,000, then the equity of this account will become USD 12,000. If another investor, who also deposited USD 10,000, buys one oil contract that ends up incurring a USD 1,000 loss, then the real value of the account, or the equity, will become USD 9,000, even if they do not close this position at that specific price.
The difference between account balance and account equity is that for the account balance to change, the trade must be closed, but for the account equity to change, that is not required, as equity fluctuates with every tick in the price of the instrument bought or sold, even without closing the position.
Back to our margin call discussion. Equity is required to be at least equal to or above the required margin. So, a margin call occurs when the equity goes below the required margin. It is that simple.
In the old days, the margin call was done over the phone, hence the name. Nowadays, and since most trading is done online, the margin call is simply a signal or notification on your trading platform. For example, in the TRADE tab in MetaTrader, the bottom row changes into a pinkish, reddish color.
This color change indicates that an action is required where the investor must either deposit some money to bring the equity up to the required margin level, liquidate other assets, or reduce one or more of the open positions in their portfolio to cover losses.
The required margin is different across the types of assets and accounts. It can vary from less than 1% up to 50%, depending on the broker you are dealing with, the asset you are trading, and the regulatory entity governing your trading account. For example, the Australian Securities and Investments Commission (ASIC) requires the minimum margin to be 3.3%.
The required margin is expressed either in percentage (for example, 1% of the total contract size) or amount (for example, USD 1,000 per contract). In all cases, investors shall meet the required margin.