Margin Trading may seem to be a complex concept for beginner level traders. Yes, there are a few risks associated with it but does that mean you should not be using it. Well, before we get to that, let’s understand some basics about this concept first.
Trading is a risky business, and sometimes it needs a huge amount of capital. For instance, if a trader wants to buy 1000 shares of a Tata Motors which is trading at ₹200 per share, he/she straight away need a principal amount of ₹2,00,000, which is a big amount of capital.
Not to ignore are the huge risks involved. At times, a trader may end up in losing the entire capital in a single trade.
Therefore, to have enough capital to trade as well as to have a cushion is an area of concern for an individual retail trader. The big corporations and trading houses can afford the big capital and their related risks, but it is not the case with individual traders who are using their lifelong savings for trading and investments.
This is the point where Margin Trading comes into effect.
Margin Trading Meaning
Margin Trading is the process of using borrowed funds from the stockbrokers to trade.
By using this process, the traders are able to buy more securities than they can otherwise afford at any point in time. Margin trading provides the traders with the required leverage, however, along with high leverage and high returns, there are also chances of huge losses.
A margin trader needs to be well aware and well prepared for this two-edged sword.
The brokerage company which had borrowed the money at low rates lends it further to the trader at higher rates and makes profits, also keeping the bought securities as collateral. However, the profits on the trader’s ends are not guaranteed. So, this may result in more losses than anticipated.
Margin Trading Definition
The technical definition of Margin Trading goes as:
Margin Trading is the process of using “extra” money from your stockbroker along with the money in your trading account balance in pursuit of amplifying profits.
This “extra” money can be termed as a loan, a credit, an advance which is provided to you at a specific interest rate.
How much margin you can be provided depends on multiple factors including the volatility of the stock you are looking to invest in, your trading history etc.
Like mentioned in this tutorial, margin trading, if goes south, can be really hazardous to your trading capital!
This needs to be understood especially by people who do not place much of research or analysis behind their trades and are impulse or gut-driven most of the times.
Because of being quite risk-prone, margin trading is regulated by various authorities like SEBI and there are various rules and regulations that have to be complied with.
Margin Trading India
The complete process of using margin (or leverage) in your trades in India requires you to follow some basic steps. Here are those listed below:
The trader opens a margin account with the broker and puts in a minimum amount of money called the minimum margin money.
Once the account is functional and the trader starts trading, he can borrow money from the broker for buying more securities than he can afford to. However, a fixed percentage of the purchase price has to be deposited in the margin account called the initial margin.
During the trade, the buying or selling has to be squared off after each session, If shares are bought, they have to be sold and vice versa at the end of each session. Based on the profit or loss made, a maintenance margin has to be maintained, which is the minimum amount after squaring off trades.
If the maintenance margin is not fulfilled, a margin call is made by the broker as soon as it is triggered due to insufficient margin funds.
Each order is converted into a delivery after the trade, which straight away goes into the broker’s account first to ensure that his debts are paid off. The trader must have enough cash to pay for the shares bought and to pay the broker’s fees and other charges.
In a sense, margin trading is a way in which a regular retail trader can look to make an extra profit if he or she is extremely confident in their trading decision.
The broker also makes money from the interest you pay while you hold the margin amount.
At the same time, both parties take some level of risk as well where the broker provides you sort of a loan and trusts your trading call. It keeps itself safe first when the shares bought are kept as collateral.
You, as a trader, also take some level of risk by trading on an amount which you might not have been able to on your own.
Margin Trading Example
Let’s take a real-life example.
Aivi, an intermediate level trader from Mumbai has ₹20,000 and he opens a margin account with his capital and ₹80,000 borrowed funds.
Here, ₹20,000 is the initial margin.
He uses the total amount of ₹1,00,000 to buy 500 shares of IBM at ₹170 per share making a total investment of ₹85,000 which is much more than he could afford without margin trading.
Now, in the first scenario, if the price of the shares goes up to ₹190 per share, he earns a profit of ₹10,000 which is a profit of 50% on his own money invested.
This shows the advantage of margin trading as he would not have been able to make high profits had he not had the leverage.
In the second scenario, if the price of the security goes down to ₹150 per share, he suffers a loss of ₹10,000 and gets a margin call. This loss needs to be paid off to the broker, along with the fee and the charges.
This shows the downside of margin trading as he would not have suffered huge losses if he had invested less money.
Margin Trading Facility
Margin Trading facility is provided by most of the registered stockbrokers in India.
However, the extent of the margin provided varies from one broker to another. A few stockbrokers go lengths and breadths to provide you with high exposure across trading segments. For instance, Angel Broking provides goes on to provide an exposure of up to 48 times in Intraday trading.
That is a lot!
While there a few stockbrokers such as Sharekhan who provide a minimalistic margin of 10 times in the same segment.
Furthermore, a few stockbrokers provide this facility by default while in other cases, you are required to submit a request in order to activate margin trading for your account.
Thus, make sure you get the requisite details from the stockbroker executive during the account opening process (or call the customer support if you are going to open demat account online).
Margin Trading Funding
So now, since you understand how margin trading works, the next bit is the funding part.
How do you actually avail margin trading funding in your account and your trades?
Well, it is automatic!
You are not supposed to perform anything to avail of this facility, as long as the margin trading has been activated (by default or post request as per mentioned in the above section) on your account. When you use any of the trading platforms provided by your stockbroker, then the available margin and exposure values will be displayed along with the scrip.
Furthermore, the margin funding value also varies based on the trade type, investment product and segment.
Margin Trading Exchanges
Under the SEBI Regulations, the facility of margin trading is provided by most of the prominent stock market exchanges in India, including, but not limited to:
Remember, more than 95% of the retail stock market investments are covered by the exchanges listed above and thus, if your stockbroker is a member of these exchanges, you will be able to use margins in your trades easily.
It is recommended that you check the broker membership details before opening your demat account.
Margin Trading Rules
There are a few margin trading rules that you need to abide by in all your margin-based trades. Although, the number of these rules is limited, however, if you fail to comply with these rules, there could be a lot of potential damages to you monetarily.
Here are the rules:
You are REQUIRED to maintain a minimum margin amount in your trading account. There is a reason for that. The stock market is volatile and you’d need never know when and what changed the value of your investments. Thus, a minimum margin is highly recommended.
You can convert the placed intraday trade into a delivery one and get hold of the stocks into your demat account. However, there will be an extra charge levied for that.
You are supposed to square-off your position before the trading session ends. If you don’t do it, the broker will go ahead and do an auto square-off. But that auto square-off will be done at the market price which might not be profitable for your trade.
Margin Trading Stop Loss
Placing a stop-loss in your margin-based trades is more like a mandate rather than just a measure.
It depends on the trading order type you are placing and based on that your stop-loss calculation is done. The best part of using it in your trade is that it will always limit your potential loss.
Like mentioned above, margin trading may result in an amplified loss as well and thus, with this provision in place, you can be relatively on ease.
Let’s take a quick example of how it works.
For instance, you are looking to buy 10 shares of ICICI that is currently trading at INR 550. While you are bullish about the stock, you want to cut losses and exit the trade if the stock price goes against your expectations.
Thus, you place the stop-loss at INR 540. This implies as the stock price actually reaches INR 540, a trade is automatically executed and you are out of your position taking a loss of (550 – 540) X 10 i.e. INR 100.
However, in case the stock price moves to INR 560, it makes sense to move your stop loss to the INR 550, thereby keeping your trade at no-gain no-loss state.
You can also use trailing stop-loss in your trades which works at a percentage level on your gains automatically.
Margin Trading Fees
Like mentioned above, when you are using margin trading, you are taking a “loan” from the stockbroker. And when you take a loan, you are supposed to pay an “interest” on the principal.
Now, in the context of the stock market, this interest rate varies from one broker to another. However, the client knows what interest rate will be charged on the margin availed.
Let’s say your stockbroker is charging an interest rate of 18%.
Now, for example, you are placing a trade worth ₹1 Lakh while taking a “loan” of ₹90k from the broker and using ₹10k from your trading account.
So, the interest for these ₹90k at 18% will be ₹90k X 18% i.e. ₹16200 for the whole year.
If you calculate the interest amount per day then it will come out to be ₹16200 / 365 or ₹44.30
So, if you are taking a T + 5 position (can be T+3 or T+10), then you will be paying ₹44.30 X 5 i.e. ₹221.5
This can be seen as your margin trading fees!
Margin Trading Good or Bad?
Well, to answer that, we need to have a quick look at both the sides of the coin.
One that advocates for this concept of stock market trading and the other against it. By having an idea about the advantages as well as the risks, you will be in a better position to decide whether it is good or bad for your stock market trades and investments.
Margin Trading Advantages
Let’s check some of the advantages of using Margin in your share market trades:
Margin trading is advantageous to be able to provide leverage to the traders. The traders are enabled to buy more securities than they can afford to and leverage their gains.
This facility can be used across trading segments. A majority of traders like to use it in intraday trading and thus, a lot of stockbrokers provide a lot of margin in this segment.
Traders can use trading opportunities as they arise, without being concerned about the cash requirements.
They are able to diversify their portfolio by hedging.
Margin Trading Risks
At the same time, here are some concerns related to Margin Trading you must be aware of:
Margin trading may lead to amplified losses if the trade does not go well.
Payment of margin call is required if the price of securities falls abruptly and the trade has to arrange cash to fulfil the margin call.
If the trader is unable to meet the margin call, the broker calls for forced liquidation of the securities kept as collateral and may generate further losses to the trader.
A trader has to pay high rates of interest and fee on the money borrowed.
As a bottom line, margin trading is a relatively risky approach and it must be practised by a trader after judiciously considering his capital, risk appetite and investment objectives. It must be used by seasoned traders who are well aware of the risks involved or by the high net worth investors who can afford the loss if that happens.
And finally, the trading decision you take for the margin amount to be used must be taken after detailed research and analysis.
One has to be very careful before taking the path of margin trading!
In case you are looking to start using margin in your trades or just want to open a demat account – fill some basic details in the form below.
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