What is Margin Trading?
- Thread starter alifkhalil469
- Start date
Margin trading means making transactions of volume that exceed your fund. You can invest, say $100, and receive credit by your broker that will enable you to make transaction of high volume. “Margin” refers to the pledge that your broker holds from your fund for opening a position of certain volume.
Margin trading is a process of trading where you trade to take advantage of the market opportunities by investing more than what you can afford to. In simple words, margin trading allows you to purchase stocks at a marginal price.
Now you might be wondering who funds these purchases. So, these kinds of trading transactions are funded by your stock broker who lends you the cash to purchase stocks, which you may otherwise not be able to afford. Against the money he lends, he keeps either the shares or cash as collateral.
The margin can be settled later when you square off your position. Furthermore, if the profit earned by you from executing the trade is higher than the margin amount, you make a profit, else you suffer a loss.
All said, margin trading is an easy way of making quick money. So, let us learn more about it.
How Does Margin Trading Work?
When you decide to carry on margin trading, the first thing you have to do is place a request with your broker to open a margin account. Now, on account opening, you will be required to pay a certain amount of money upfront to your broker in cash. This amount is known as the minimum margin. The margin varies across brokers. Now, just in case the transaction you entered into didn’t go well, you make heavy losses and fail to recuperate the money, in such scenarios, the broker can use the minimum margin amount to square off the position and recover some money.
Once your margin account is opened and when you want to execute any transaction, you will be required to pay an initial margin. This amount is pre-determined by the broker and is a fixed percentage of the total traded value.
Apart from the above, you are also required to maintain a minimum balance at all times. If you fail to maintain the minimum balance, then the broker has the right to square off your trade. Like for example, if Mahindra & Mahindra’s stock priced at Rs. 400 falls 4.25% and the initial margin and minimum margin are 8% and 4% respectively of the total value of the shares bought, then the trade-off (i.e. 8% - 4.25% = 3.75%) will be lower than the minimum margin. In such a scenario, you might be required to pay more money to your broker in order to maintain the margin or else the broker will automatically square-off your trading position.
The squaring-off position is compulsory at the end of each trade session. Meaning, if you have bought shares today, you will have to sell them today before the market closes. Likewise, if you have sold shares today, you will have to buy them today before the market closes.
However, there is an option of taking delivery by paying for the entire trade (buy or sell) during the session along with broker’s fees and additional charges.
Benefits of Margin Trading
Some of the benefits of margin trading are as follows:
- Margin trading is ideal for investors who aim to take the opportunity of price fluctuations over a short period but do not have enough money in hand.
- Margin trading helps you to leverage your position in securities that are not from the derivatives sector.
- Margin trading helps you earn a better rate of return on your investment.
- It enhances your purchasing power.
- The shares and securities kept in your demat account can be used as a collateral for margin facility.
- The margin trading facility is continuously monitored and regulated by The Securities and Exchange Board of India (SEBI) and stock exchanges.
- Since margin accounts can be offered only by authorised brokers, it provides more safety and security to the investors.
The Bottom Line
Margin trading can be a great way of earning in the stock market. However, the risks associated with it are also high. If not done with caution and disciple, you may end up losing more money than you had invested. Therefore, it is crucial to gauge your risk appetite before investing money in margin trading.
Now you might be wondering who funds these purchases. So, these kinds of trading transactions are funded by your stock broker who lends you the cash to purchase stocks, which you may otherwise not be able to afford. Against the money he lends, he keeps either the shares or cash as collateral.
The margin can be settled later when you square off your position. Furthermore, if the profit earned by you from executing the trade is higher than the margin amount, you make a profit, else you suffer a loss.
All said, margin trading is an easy way of making quick money. So, let us learn more about it.
How Does Margin Trading Work?
When you decide to carry on margin trading, the first thing you have to do is place a request with your broker to open a margin account. Now, on account opening, you will be required to pay a certain amount of money upfront to your broker in cash. This amount is known as the minimum margin. The margin varies across brokers. Now, just in case the transaction you entered into didn’t go well, you make heavy losses and fail to recuperate the money, in such scenarios, the broker can use the minimum margin amount to square off the position and recover some money.
Once your margin account is opened and when you want to execute any transaction, you will be required to pay an initial margin. This amount is pre-determined by the broker and is a fixed percentage of the total traded value.
Apart from the above, you are also required to maintain a minimum balance at all times. If you fail to maintain the minimum balance, then the broker has the right to square off your trade. Like for example, if Mahindra & Mahindra’s stock priced at Rs. 400 falls 4.25% and the initial margin and minimum margin are 8% and 4% respectively of the total value of the shares bought, then the trade-off (i.e. 8% - 4.25% = 3.75%) will be lower than the minimum margin. In such a scenario, you might be required to pay more money to your broker in order to maintain the margin or else the broker will automatically square-off your trading position.
The squaring-off position is compulsory at the end of each trade session. Meaning, if you have bought shares today, you will have to sell them today before the market closes. Likewise, if you have sold shares today, you will have to buy them today before the market closes.
However, there is an option of taking delivery by paying for the entire trade (buy or sell) during the session along with broker’s fees and additional charges.
Benefits of Margin Trading
Some of the benefits of margin trading are as follows:
- Margin trading is ideal for investors who aim to take the opportunity of price fluctuations over a short period but do not have enough money in hand.
- Margin trading helps you to leverage your position in securities that are not from the derivatives sector.
- Margin trading helps you earn a better rate of return on your investment.
- It enhances your purchasing power.
- The shares and securities kept in your demat account can be used as a collateral for margin facility.
- The margin trading facility is continuously monitored and regulated by The Securities and Exchange Board of India (SEBI) and stock exchanges.
- Since margin accounts can be offered only by authorised brokers, it provides more safety and security to the investors.
The Bottom Line
Margin trading can be a great way of earning in the stock market. However, the risks associated with it are also high. If not done with caution and disciple, you may end up losing more money than you had invested. Therefore, it is crucial to gauge your risk appetite before investing money in margin trading.
Using margin trading, you can purchase more stocks or cryptocurrencies than you could with your own funds by borrowing money from a broker. It raises the possibility of losses even as it amplifies possible rewards. Leverage is the term for the borrowed funds, and you must open a specific account for it. On the other hand, you may need to fund your account with new funds or liquidate some investments if the value of your investments drops too significantly. Interest charges apply when using borrowed money. Profitability notwithstanding, it's dangerous and not appropriate for everyone. In margin trading, it's essential to comprehend the dangers and take precautions to manage them.
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