What is Forced Liquidation?
Forced liquidation is the sale of all investments within a customer's margin account by a brokerage firm, usually after the account has failed to meet margin requirements and margin calls.
How Does Forced Liquidation Work?
To engage in trading investments on margin, brokerage firms generally require their investing clients to follow the firm's rules on margin requirements.
If an investment that was bought on margin drops in price, the account may become under-margined. The brokerage firm may then issue a margin call, notifying the client that they are under-margin in the account, and that they must either deposit more cash or sell some of the shares to offset all or part of the difference between the actual stock price and the maintenance margin.
Should the client fail to meet the margin requirements within the brokerage account, the firm holding the account has the right to force liquidate; they may sell off and close all open investment positions held in the account.
Why Does Forced Liquidation Matter?
Brokerage firms use forced liquidation to protect themselves from the potential losses from under-margined accounts that are exposed to a declining value investment.
If a client with a margin account fails to respond to a margin call when their margined investment drops in value, the brokerage firm (who also allowed the client to borrow from them on margin) may be on the hook and suffer losses if they don't sell the investment.