Maintenance Margin vs. Margin Accounts: Key Differences Explained 

Margin trading allows investors to borrow funds from brokers to increase their purchasing power, offering potential for higher returns but also greater risks. Two crucial aspects of margin trading are maintenance margin and margin accounts. If you’re considering margin trading, then understanding their differences and nuances is essential for making informed trading decisions. 

What is Maintenance Margin? 

Let’s start by understanding what ‘maintenance margin’ is. Maintenance margin refers to the minimum amount an investor must maintain in their margin account to continue with the leveraged positions they have taken. It is a safeguard designed to protect both the investor and the brokerage from excessive losses in case the value of the securities declines severely. If your equity falls below this level due to market fluctuations, the broker will issue a margin call, requiring you to deposit more funds or sell some of your holdings to meet the margin requirement. 

The maintenance margin acts as a safety net in leveraged trading. Without it, a sharp decline in the value of your investments could leave you unable to repay the borrowed amount, resulting in significant losses for both you and the broker. That’s why most brokers require a maintenance margin of 25%-30% of the total market value of the securities in the account. However, this can vary depending on the broker and the type of securities being traded. 

Understanding Maintenance Margin in Detail 

Let’s understand the concept of maintenance margin with a detailed example. Imagine you want to purchase stocks worth ₹ 2,00,000, but you only have ₹ 1,00,000. To complete the transaction, you borrow the remaining ₹ 1,00,000 from your broker using a margin account. 

Step-by-Step Breakdown: 

1. Initial Investment: 

• Total value of stocks = ₹ 2,00,000 

• Your equity = ₹ 1,00,000 

• Borrowed amount = ₹ 1,00,000 

• Equity percentage = ₹ 1,00,000 ÷ ₹ 2,00,000 = 50% 

2. Maintenance Margin Requirement: 

• The broker sets the maintenance margin at 30% of the current market value of the stocks. 

• Minimum equity required = ₹ 2,00,000 × 30% = ₹ 60,000 

3. Stock Price Drops: 

• Suppose the stock value falls to ₹ 1,50,000. 

• New equity = ₹ 1,50,000 (stock value) - ₹ 1,00,000 (borrowed funds) = ₹ 50,000 

• New equity percentage = ₹ 50,000 ÷ ₹ 1,50,000 = 33.33% 

• Since your equity is above the 30% maintenance margin, there’s no margin call. 

4. Further Drop in Stock Value: 

• If the stock value falls to ₹ 1,40,000, the equity becomes: 
  ₹ 1,40,000 - ₹ 1,00,000 = ₹ 40,000. 

• New equity percentage = ₹ 40,000 ÷ ₹ 1,40,000 = 28.57%, which is below the 30% maintenance margin. 

• The broker issues a margin call requiring you to deposit an additional ₹ 2,000 to bring your equity up to the minimum level of ₹ 42,000 (30% of ₹ 1,40,000). 

5. Response to Margin Call: 

• You can either: 

• Add funds to your account. 

• Sell some securities to reduce the borrowed amount. 

• If you fail to act, the broker may forcibly liquidate your securities to restore the margin requirement. 

What are Margin Accounts? 

A margin account is a brokerage account that allows investors to borrow funds from their broker to purchase securities. Unlike cash accounts, margin accounts enable leverage, magnifying both potential gains and losses. 

Key Features and Considerations of Margin Accounts 

• Leverage: You can borrow funds to increase your purchasing power. 

• Interest: You need to pay interest on borrowed amounts. This varies across brokers and can be as high as 15-18%.  

• Regulations: To ensure safety and security, it is important to open a margin account with a reputed and SEBI-registered broker.  

• Risk Management: Familiarise yourself with initial and maintenance margin requirements so your account remains compliant with the requirements at all times. Use stop-loss orders to limit potential losses. Avoid overleveraging, as it can lead to significant losses. 

• Monitor Account Regularly: Keep track of the value of your securities and equity to avoid margin calls. 

Benefits of Margin Accounts 

• Increased Buying Power: Enables larger investments than your cash balance allowing you to buy stocks or take positions that would not have been possible with your own capital. 

• Flexibility: Offers higher flexibility and liquidity for trading opportunities. 

• Potential for Higher Returns: Amplifies potential profits in bullish markets that can easily offset the interest and any other charges levied by the broker. 

Risks of Margin Accounts 

• Amplified Losses: While potential profits can rise, the losses can also significantly increase if investments decline or movement happens against your expectations. 

• Margin Calls: You may be forced to sell your assets at unfavourable prices if a margin call is raised, or the broker may forcibly liquidate the pledged holdings if you’re unable to meet the margin criteria. 

• Interest Costs: Borrowed funds incur interest (and other charges) that can reduce your overall returns. 

Relationship Between Maintenance Margin and Margin Accounts 

The maintenance margin and margin accounts are closely interlinked concepts in margin trading, forming the backbone of leveraged investing.  

The margin account enables leveraged trading, while the maintenance margin ensures that your equity does not drop to dangerously low levels. Let’s understand their interplay: 

1. Initial Investment in a Margin Account: 
   When you open a margin account, you deposit an initial margin (a percentage of the total trade value) to secure the loan from your broker. The remainder is financed by the broker. This sets the foundation for your trading activities. 

2. Monitoring Equity Levels: 
   As market conditions change, the value of your securities may rise or fall. The maintenance margin requirement is the threshold at which your equity (your own capital) must remain to avoid a margin call. 

3. Margin Call Triggered by Maintenance Margin: 
   If your equity drops below the margin requirement, your broker will issue a margin call. This is a direct result of the relationship between the borrowed funds in your margin account and the maintenance margin requirement. 
   For instance: 

• If the market value of your securities drops, your equity percentage also declines. 

• If this percentage drops below the maintenance margin (e.g., 25-30%), you must act to restore the balance. 

4. Broker’s Role in Managing Risks: 
   Brokers enforce the maintenance margin as a way to mitigate their risk. If you don’t meet the margin call, the broker has the authority to liquidate your securities to restore the required equity levels. 

Conclusion 

Maintenance margin and margin accounts are fundamental aspects of margin trading, offering opportunities for amplified gains but also carrying significant risks. By understanding their interplay and adhering to best practices, you can manage your investments effectively. Always consider the costs, risks, and regulations involved to make informed trading decisions.