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As a sea of red engulfed stock market trading screens on Monday, Donald Trump had a simple message for investors: “Don’t panic.”

Yet for many Wall Street investors facing “margin calls” this week, Trump’s message is likely to ring hollow.

“Margin call” are among the most feared words whispered on Wall Street, enough to strike terror into billionaire entrepreneurs and high-rolling hedge fund bosses alike.

They are feared because they have the potential to ruin careers and leave investors penniless.

Here’s what it all means:

What is a margin call?

Margin calls are formal demands from an investment bank to borrowers such as hedge funds or wealthy individuals asking them to stump up more cash to cover a loan. They typically occur when markets are in free fall or when they enter a “bear market”.

They may sound technical and complex but margin calls are founded on a familiar concept.

When a homeowner takes out a secured personal loan, they borrow the cash from the bank “secured” against the house they own. If they cannot repay the loan, the bank gets the house.

The same principle applies on Wall Street – but on a much larger and more frightening scale.

Instead of property, hedge funds and wealthy individuals will typically obtain a loan by pledging a portfolio of shares to large investment banks such as Goldman Sachs, JP Morgan or Morgan Stanley.

The catch is that if the value of these shares falls below a certain point, banks will demand extra funds to make up the shortfall.

While the idea itself is simple, the squeeze on financial institutions and financiers to find this emergency funding when shares fall can be devastating.

What is a bear market?

The market rout on Monday following Trump’s tariffs has raised the prospect of a wave of margin calls against borrowers such as hedge funds.

Stocks have fallen to such a degree that US financial markets have now entered a “bear market”, another piece of financial jargon financiers throw around to confuse the public.

A bear market describes when a stock market index has fallen 20pc from a recent peak.

For example, the S&P 500 reached a record 6,144 points in February. The index plunged to 4,965 points on Monday – a fall of 20pc. Bear markets are also used as shorthand to describe a period when investors are gloomy.

The bear market – the FTSE 100 fell 6.2pc and the S&P 500 was down 5.7pc on Monday – means borrowers are likely to be facing huge pressure to stump up more cash to cover their margin loans.

How do margin calls work?

One hedge fund manager based in Hong Kong said banks had already started making margin calls on those investors who are most exposed to market volatility.

He said prime broking desks were particularly concerned about hedge funds who had used significant borrowing to boost their returns as well as computer-driven trading funds, which are more exposed to market crashes.

Hedge funds are typically the largest clients for these margin loans because they allow them to juice up returns on their investment strategies.

Banks are happy to lend to them when markets are rising because they assume the risks are low. When markets drop, however, panic sets in.

To meet margin calls, funds start liquidating their holdings to pay for the emergency funding, creating a vicious cycle of selling which pushes stock prices down further.

If funds cannot meet their margin calls, the loans are liquidated and the companies have to pay back the loans in full.

Bruno Schneller, managing partner at Erlen Capital Management, said he had seen a surge of margin calls since markets began crashing last week.

“Hedge funds are facing their harshest collateral demands since the 2020 Covid crash,” he said.

“As asset values crater, loan covenants – those critical safety nets for leveraged bets – are breached, forcing funds to either inject cash or offload holdings into a plummeting market, amplifying the sell-off spiral.”

Who does a margin call affect?

It is not just hedge funds which are likely to be affected. High-rolling chief executives often pledge their shares as collateral to raise funds from Wall Street.

Although many large corporations have historically banned executives from having margin accounts, like so many things in corporate America, the tech sector has upended this tradition.

Shortly after he purchased X, then known as Twitter, Elon Musk, the Tesla founder, discussed using his Tesla shares as collateral for a margin loan. Morgan Stanley was scheduled to help refinance debt taken out through his Twitter purchase by offering the loan pledged against the Tesla shares.

While such moves sound financially savvy when stock prices are rising, the consequences can be devastating when markets crash.

In 2022, John Foley, the former Peloton chief executive, faced repeated margin calls from Goldman Sachs on his personal loans after Peloton shares crashed once the post-Covid cycling boom wore off.

According to stock market filings, Foley had pledged 3.5m Peloton shares as collateral. As Peloton shares sank 95pc, the value of those shares slumped from $300m to just $30m – prompting Goldman to demand more funding.

Reports said Foley faced repeated margin calls and eventually managed to secure private financing to stave off the margin call.

When does a margin call occur?

In the UK, personal margin loans are less common but can lead to huge bust-ups with bankers if margin calls are made.

In 2021, billionaire retail tycoon Mike Ashley’s Frasers Group was subject to a $1bn margin call from Morgan Stanley over Frasers’ trading positions in German fashion giant Hugo Boss.

Frasers subsequently sued the Wall Street investment bank over the demand, but later dropped its lawsuit before a court ruling.

The margin call ultimately required Frasers to deposit extra cash to cover a potential 400pc move in Hugo Boss’s share price.

Ashley argued the decision was “arbitrary” and the extraordinary cash sum was disproportionate to any risks the bank faced, a claim denied by Morgan Stanley.

With markets in free-fall, the danger is that there will be more of such clashes, with fears mounting that Trump’s tariffs could end up blowing up weaker parts of the financial system.

“The mechanics are stark: tariffs slash equity valuations, triggering margin pressures that push leveraged players — hedge funds, speculators, and more — to liquidate at the worst possible time,” said Schneller.

Trump will likely want to assuage investors’ fears. Schneller says it may be a tough ask. “It’s a self-feeding loop, thriving on velocity and dread.”

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