Understanding Margin Calls & Liquidation

What is Margin Trading?

Margin trading allows you to borrow funds from a broker to trade larger positions than your cash balance would normally permit. While leverage magnifies potential profits, it equally magnifies potential losses. If a leveraged trade moves against you, your broker will require you to maintain a minimum amount of equity in the account, known as the Maintenance Margin. If your equity falls below this threshold, you will face a Margin Call or outright liquidation of your position.

The Mathematical Formula

To calculate the exact price at which a long position will be liquidated (or face a margin call), use the following formula:

Practical Trading Scenario

Suppose you buy a stock at $100 using 50% initial margin (you put up $50, the broker lends you $50). The broker's maintenance margin requirement is 25%.

Using the formula, your liquidation price is: ($100 * (1 - 0.50)) / (1 - 0.25) = $50 / 0.75 = $66.67.

If the stock price drops to $66.67, your equity in the position will equal exactly 25% of the total position value. At this point, the broker will issue a margin call requiring you to deposit more cash, or they will automatically sell your shares to protect their loaned capital. Knowing this level in advance is critical for setting stop losses *above* your liquidation price.