What Is Margin and Should You Invest in It?
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In this article, we will discuss
Traders often fail to cash on some really great opportunities due to a lack of sufficient funds available to them. It is in this situation that margin trading can come to their aid. In this blog, we have discussed what is margin, the advantages and risks associated with it, eligibility and everything else you need to know about it. Read it till the end to gain detailed knowledge on margin in the share market.
What is Margin Trading?
In simple words, margin trading is a stock market feature that allows traders to purchase more shares than what they could otherwise afford to. Think of it as a loan from your stockbroker. You put a certain amount as a down payment, and you borrow the balance from a bank to afford the shares. In margin trading, you put down a certain amount of money upfront, and your stockbroker funds the rest.
The money you put upfront is called the margin, and for the remaining amount you borrowed, your broker levies a periodic interest on the same. This margin is settled when you square off your position. To make profits, your net profit must be higher than your margin value, or you would end up with losses otherwise.
Previously SEBI permitted traders to only use cash for margin trading. However, in 2018, it also allowed traders to pledge their securities as margin. Therefore, if you have any shares or securities in your demat account, you can put up a pledge request with your stock broker. Once the request successfully carries through, your broker will lend you the funds to leverage your margin in the share market.
Key Features of Margin in Share Market
Here are some of the important points to keep in mind before you carry out a margin trade.
- Any trader who wants to carry out margin trading will first have to open a Margin Trading Facility (MTF) account with their brokers. This is the account where your broker will credit funds for margin trading.
- The margin requirement varies with different brokers. When you open your MTF account, you will be required to pay a certain sum of money for the same.
- A Margin Trading Facility can only be offered by authorised brokers. Hence, it is very important for every trader to conduct thorough research before creating an MTF account.
- The securities that are eligible for margin trading are pre-defined by SEBI and the stock exchanges. So make sure to check them as well before opening an MTF.
Example of Margin Trading
Now that you have a basic idea of what is margin, along with some of its relevant features, let’s take up an example to understand it better.
Suppose you have ₹10,000 in your MTF, and you want to buy stocks worth ₹20,000 trading at₹100 per share. Now if you take a loan from your stockbroker, you can easily buy shares worth ₹20,000 for just ₹10,000. Here your account balance would still reflect ₹10,000, but your stocks would reflect a value of ₹20,000.
Further, if the price of the share moves up to ₹ 120 per share, your account balance would be ₹14,000 after deducting the value of the margin loan. This means you gained a 40% profit on your stocks with just a 20% increase in its price.
However, because it is a two-way street, the situation can also be reversed. So, if the stock price fell by 20% and came down to ₹80 per share, the value of your shares would come down to a total of ₹16,000. At this point, your account balance would be ₹6,000. This means you would face a loss of 40% with just a 20% decrease in the price of securities.
Different Components of Margin in the Share Market
There are mainly three types of margins you must be aware of before making a margin trade or even opening a margin account.
This margin amount is the money you pay to your broker for opening a Margin Trading Facility account. This is an unavoidable expense, and every trader will have to pay this money in order to open their account. However, you can compare MTF facilities from different brokers to pick an account with the least cost.
To be able to make margin trade, you must also pay a certain amount of money upfront. Most stockbrokers have a requirement of a minimum of 50% for the same. This upfront payment that you make is called Initial Margin. Taking the above example, ₹10,000 that you paid from your own pocket is your initial margin.
When you carry a margin trade, remember no matter what your choice of action is, your stockbroker will never face any loss on your behalf.To avoid such losses, they have a requirement of maintenance margin. This is a percentage of the total value of the stocks purchased that you must maintain in your account all the time.
Continuing with the same example, let’s say your broker has a maintenance margin requirement of 30%. Hence, you will have to maintain a minimum balance of ₹6,000 (30% of ₹20,000) of your funds in your account all the time.
What Is the Meaning of Margin Call?
As soon as your stockbroker realises that your account value is dropping below the maintenance margin, they will ask you to add more funds to keep your trade open. The broker can try to contact you via calls or emails to add the requisite funds.
However, do remember that a broker is not liable to make any margin calls to remind you to add more funds. Additionally, if you fail to meet the maintenance margin, the brokerage firm will sell your share to meet this requirement.
Now if we take the scenario of loss from the above example, you would see the account value is already at ₹6,000. Depending on your broker, they may or may not make a margin call, but you would still be required to meet the maintenance margin if the value goes below ₹6,000. If you fail, the stockbroker will sell securities on its own without waiting for you to meet the margin requirement.
Advantages of Margin Trading
Margin trading has proved to be a major source of profits for many investors. Here are some of the key benefits of trading on margin in the share market.
- It is one of the best alternatives for traders looking to leverage short-term profit opportunities in the market but lack sufficient capital for the same.
- Investors get an opportunity to gain maximum returns in a given situation with limited capital. They can make more profit with margin trading as compared to common trades.
- Traders who do not have sufficient funds to contribute even towards the initial margin can also pledge the securities they own. This relieves them from the compulsion of having to possess funds to trade in the market.
- SEBI has made several provisions to ensure that the entire process of margin trading is transparent. This ensures the safety of a trader’s funds and securities.
Risks of Margin Trading
Leveraging margin to make profits in the market may sound quite tempting. However, there are several risks associated with it. It is crucial for an investor to be aware of them before deciding to margin trade.
- Margin trading carries a high risk of losses. If the market trend goes against your strategy, you can end up losing your entire capital. Additionally, you will still be liable to pay interest and other charges on the borrowed funds.
- If you do not have sufficient funds to keep the maintenance margin, the broker can square off your position. The firm won’t take into consideration your viewpoint of future predictions. You will just end up losing more than you could afford.
- You are liable to pay interest on the borrowed funds. Hence the longer you keep your position open, the more interest you pay.
- It is very rare to predict accurate timings in the market. Hence in certain situations, irrespective of how careful you are, you can still end up at a loss.
- Sometimes even the most seasoned investors end up incurring losses on a margin trade; hence, it is not suitable for novice traders.
Should You Invest In Margin in the Share Market?
Before you make the big decision to open a Margin Trading facility, there are certain parameters you should take into consideration. If you think they are in your favour, then you can consider margin trading.
Margin trading carries a high level of risk. Therefore your first question should be if you have enough funds to help you combat any unforeseen financial emergency. If your answer is yes, you can consider using the surplus for margin trading. However, if your answer is no, it would be better for you to invest your money in safer financial instruments and build a financial cushion for yourself.
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Your knowledge of the market:
Margin trading is not suitable for novice investors. Hence, unless you possess a good knowledge of the market trends, strategies, operations and other rules and regulations, maybe you should hold back on margin trading.
If you are margin trading to meet your other financial obligations, then it can sometimes hinder your judgement. It is very crucial for an investor to not take their decision based on their impulse and emotions. So, if you have debts or other obligations, meet them first because you may end up losing all your capital otherwise.
How to Minimise Risk in Margin Trading?
While it is impossible to completely eliminate the risk from margin trading, you can take certain measures to minimise it. Here are a few suggestions you can follow:
- Always have some surplus cash in your margin account. This would prevent your broker from forcefully squaring off your position to meet the maintenance margin.
- Always set your maintenance margin higher than your brokerage firm. This would prevent you from reaching the broker threshold as you will get some time to infuse more cash into your trade.
- Since interest charges are computed on a compounding basis, make sure to pay your interest regularly.
Conclusion
Now that you understand what is margin trading, you also understand the risks associated with it. Hence, if you are a beginner in such trades, it is very important to exercise caution. Always have the patience to study the markets before diving straight into the trades. Conduct some research, understand the trends and always take sufficient measures to minimise your risk for successful margin trades.
If you use the New-gen Samco trading app for your margin trades, you will not only get guidance on your next trades, but you will also get charts and data analysis based on your past trading behaviour, performance comparison with other traders to help you ace the index like a pro.
FAQs
Q1. What is margin limit?
Ans. It is the maximum amount of funds that your borrower will lend you. It is calculated as a portion of the entire value of the securities in your account.
Q2. Can I trade without a margin while using a margin trading account?
Ans. Yes, you can always choose to trade without margin, even with an MTF account.
Q3. Does stock volatility affect margin?
Ans. If a stock shows signs of high volatility, chances are that your stockbroker would increase the margin requirement. This is to avoid risks in case the stock price goes down in the future.
Q4. Are all securities available for margin trading?
Ans. No. Only those shares that have been classified by SEBI for the same purpose are eligible for margin trading. They are listed as Group 1 securities.
Q5. What does 5x margin mean?
Ans. It is a leverage ratio to express margin. A 5x margin means you can buy shares worth 5 times their market price. For example, if a share is trading at ₹1,000, you can buy that share worth ₹5,000 on margin.