5paisa Research Team
13th March 2023
How Margin Trading can help Minimise Risks in Online Trading?
Margin trading globally refers to borrowing money and investing in stocks. In India, margin trading has a wider definition. The first approach of borrowing from your broker and paying interest to hold a position is a normal method of leveraging. The second aspect of margin trading is an intraday strategy due to rolling settlements. Traders are allowed to take a larger intraday position as a multiple of their margin money. To that extent, it does become a form of margin trading and since these are strictly intraday trades, they have to be closed the same day.
Intraday trading as a form of margin trading
When you trade online, intraday is quite simple. You select the order as an MIS order and ensure that your account is funded with sufficient margin. You can get leverage up to 4-5 times the value of the margin you put in. You can use bracket orders or cover orders which include stop loss and profit targets to maximise leverage. The advantage of intraday trading is that you can play stocks on the long side and the short side. Of course, either way you need to necessarily close out the position the same day. Intraday trading reduces risk as you trade more in sync with the underlying trend of the market and avoid contrarian bets. Since stop losses and profit targets are normally built in, it further protects capital better.
Margin financing for delivery
What do we understand by margin financing? It is a line of credit given by your broker to allow you to buy more than you can currently afford to invest. Margin financing has a funding cost and hence it must only be used when you expect momentum on the stock price. Can you use margin finance effectively?
|
Without Borrowing |
Amount |
With Borrowing |
Amount |
|
Balance in Trading A/C |
Rs.1,00,000 |
Balance in Trading A/C |
Rs.1,00,000 |
|
Borrowed Margin |
- |
Borrowed Margin |
Rs.200,000 |
|
Total Investment |
Rs.1,00,000 |
Total Investment |
Rs.3,00,000 |
|
Returns of 20% |
Rs. 20,000 |
Return of 20% |
Rs.60,000 |
|
Interest Cost |
- |
Interest Cost (18% p.a.) |
Rs.(36,000) |
|
Net Returns |
Rs.20,000 |
Net Returns |
Rs.24,000 |
|
Returns |
20% |
Returns |
24% |
The trader has been able to enhance yields by availing margin finance because the returns on the stock far outweigh the cost of borrowing. However, one needs to remember that such interest costs are fixed commitments and have a magnifying impact when stock prices correct.
Does margin trading really minimize your risk?
Prima facie, margin trading appears to be a risky bet. But in reality, the discipline it instills into your Online Trading makes it a lot safer. Here is how.
-
While cash market investing only permits taking positions on the long side, online trading via the intraday route enables you to take positions on the long and short side. This actually de-risks your equity portfolio by introducing a negative correlation.
-
The advantage with margin trading is that you can also leverage your holdings by taking positions against your demat holdings instead of bringing in cash margins. The cash can be redeployed to lower risk investments. You can go for online trading as well.
-
A lot of opportunities in a market like India are created in the short term. By using margin trading for short-term, you make your portfolio strategy more flexible.
Margin trading, if used intelligently, can enhance returns without unduly enhancing your risk. The secret lies in the trade-off.
Tanushree Jaiswal