What is Margin Trading?
Margin Trading is a stock market feature, allows investors to purchase more stocks. Investors can earn high returns by buying stocks at the marginal price instead of market price. Here stockbroker will lend money to buy stocks and like a loan they will charge interest. Investor will have access to larger amount than existing funds. There are two types of margin traders .This margin is paid either in cash or in shares as security. Here broker funds margin trading transactions. The margin can be settled later when you square off your position. You make a profit when the profit earned is much higher than the margin.
Components of Margin Trading
- Investors who are willing to do margin trading should provide an undertaking by initiating their acceptance of all terms and conditions applicable to the MTF.
- The margin trading facility is not a separate trading account. It is offered in the same existing trading account and linked Demat Account.
- Traders who get MTF facility could provide their margin amount either in cash or in equity collateral.
- The MTF facility lets the investor create a leveraged position in securities as a multiple of what they could afford. This especially is relevant in the non-derivative segment where future leveraging is not possible.
- There is no standard limit to the number of days the position could be carried forward and this is at the discretion of the broker.
- Brokers can’t offer margin trading facilities on all the stocks listed on the stock exchange. The master list is defined by SEBI, which is the outer limit of offering the MTF facility to clients. However most brokers also impose their own level of checks and balances.
- SEBI allows only allow corporate brokers registered with SEBI to offer the margin trading facility.
What is the Meaning of a Margin Account?
The term margin account refers to a brokerage account. Here trader’s broker lends cash to purchase stocks or other financial products. The margin account and the securities held within it are used as collateral for the loan. This includes interest rates which are periodically charged. Investing through margin accounts means using your leverage which increases the chances of profits.
Who is Eligible for Margin Funding?
The trader needs to maintain a margin account with the broker to get the margin trading facility. The margin varies from broker to broker. The trader has to pay certain amount before opening the margin trading account. In this account the trader needs to maintain minimum balance every time. If the minimum balance is not maintained the trade gets squared off. The squaring off position is mandatory at the end of every trade session.
What are the benefits of Margin Trading?
The advantage or benefits of Margin Trading is mentioned below
- Margin trading is for those investors who are looking for the opportunity of short term price movement but do not have sufficient cash balance. Here margin trading fills the gap and provide liquidity.
- If shares are lying idle in Demat Account the Margin Trading facility is a good way of utilizing or leveraging stocks.
- Margin trading helps in increasing the percentage return on the capital deployed that means it helps in improving ROE. When trading in margins only 25% of the cost is paid. So if price moves up 5% it is a ROE gain for you.
- Many times investors miss out opportunities because they do not have the liquidity available. In such cases the margin trading facility help to take advantage of the opportunities.
- This borrowing of funds in the form of loan appreciates the asset value in the long run.
What Is a Margin Call?
A margin call is a scenario in which a broker who had previously extended a margin loan to an investor sends a notice to that investor asking them to increase the amount of collateral in their margin account. When faced with a margin call, investors often need to deposit additional cash into their account, sometimes by selling other securities.
If the investor refuses to do so, the broker has the right to forcefully sell the investor’s positions in order to raise the necessary funds. Many investors fear margin calls because they can force investors to sell positions at unfavorable prices.
What is E Margin Trading?
E Margin Facility empowers you for extra buying and at the same time positions you with the extra added time for positional trades. It allows to hold on to your stocks for 275 days. A higher leverage means higher profits. It enhances buying power as you need to pay only a small portion of the stock/ETF value. It amplifies profit potential due to increase in the investment horizon. It provides higher leverage to benefit from short term fluctuations.
What are the Precautions to be Taken In Margin Trading
- Stop Loss is Essential
If you are trading on Margin Trading then stop loss is very important. There must be discipline and try not to average positions if the price moves against you.
- Profit Booking
The second important thing is to have discipline for profit booking. Try to reduce turnaround time for your positions. That is the best bet against volatility.
Take Ownership of your margin trading position and do not leave it for the broker. Set a time limit and close out within the time limit.
- Cost and Breakeven point to be calculated
Don’t get in to margin funding position without knowing the cost and breakeven point for position. There are other costs to the margin funding like administrative charges, DP charges and processing charges which are additional to interest amount.
- Margin trading and Margin Funding are good ways of leveraging your capital but at the same time precautions must be taken. Margin trading is the practice of borrowing money, depositing cash to serve as collateral, and entering into trades using borrowed funds.
- Through the use of debt and leverage, margin may result in higher profits than what could have been invested should the investor have only used their personal money. On the other hand, should security values decline, an investor may be faced owing more money than what they offered as collateral.