What is Margin Trading?
Margin trading involves borrowing money from a broker to buy stocks, allowing investors to purchase more than their current funds permit.
It is a useful feature provided by stockbrokers that help investors take a larger position and consequently boost their possible gains. To avail margin trading facility, one has to place a request with the broker to open a Margin Trading Facility (MTF) Account. The broker specifies a minimum balance that needs to be maintained in the margin account, called minimum margin. Before initiating a trade, investors will have to deposit a certain percent of the total traded value and the remaining will be funded by the broker. An interest rate is charged by the broker on the funded amount.
How Margin Trading works
Once Margin Trading Facility (MTF) account is opened, the broker can disburse funds in it which the investor can use to buy shares. The amount disbursed is a loan provided against the collateral of cash (minimum margin) or the purchased securities.
Suppose an investor wants to buy shares worth Rs. 1,00,000 but he doesn’t have the entire amount. However, he can pay a portion of the total amount for buying the shares. This amount is the margin.
Assume that the margin in this case was 20%. Then, the investor must give Rs. 20,000 (20% of Rs. 1,00,000) to the broker before buying, while the remaining Rs 80,000 will be lent by the broker. The investor will pay interest to the broker on the margin amount.
Advantages of Margin Trading
- Ideal for short-term profit generation:
Margin trading is beneficial for investors looking for profit-making through short-term price fluctuations in the stock market but facing a shortage of cash for investing. - Leverage market position:
Margin Trading enables an investor to buy large volumes of stock with a smaller amount and thus, amplifies their leverage. Leverage puts them in a favourable position where one can take advantage of even small market movements. But one needs to manage it cautiously as negative price movement also amplifies the losses proportionally.
Margin trade is advantageous only when the rate of return is higher on the investment than the interest on the loan. It magnifies gains as well as losses.
Suppose you have invested Rs. 50,000 in stock with anticipation of higher returns but the stock value has decreased to Rs. 45,000. You have to bear the losses as well as the payment of interest on the loan from the broker.
Margin Call
Margin call takes place when a margin account balance is less than the minimum maintenance margin. Usually, a margin account goes low on funds due to a losing trade. Broker has the right to insist traders to deposit funds to maintain the minimum maintenance margin. If the trader is unable to do so, the broker can square off the order at the market price.
Risks involved in Margin Trading
- Magnified Losses
Margin trading can help boost returns but on the other hand, it magnifies losses as well. It can lead to the loss of the entire invested capital as well. - Minimum Balance
Investor needs to maintain a minimum balance in the margin trade facility account. This means a portion of their capital is always locked in. If the account balance depletes below the minimum required balance, the broker will insist the investor to maintain the minimum balance by adding cash or selling a portion of their holdings. - Liquidation
Investors must abide by the rules associated with using the margin trading facility. For example, if an investor has taken a position through margin trading and the trade is going bad, leading to the balance falling below the minimum margin, then a margin call is triggered. If the investor does not honour the margin call, the broker can square off the position and liquidate the assets.
SEBI regulations regarding Margin Trading
SEBI has implemented new margin rules to bring transparency and safeguard the interests of investors. Some of the key points are as below:
Before | Now | |
Initial margin required in cash segment | No | On T day, Minimum 20% margin required, for margin reporting |
Initial margin required for selling of shares | No | Minimum 20% initial margin required even while selling of shares. To avoid initial margin, Broker will do early pay-in |
Penalty on short margin | No | Yes |
Pledging of shares | To pledge shares to obtain margin, the investor has to transfer the shares to the broker's account or give Power of Attorney to Broker | The shares will remain in the investor's Demat Account and limit on shares given as collateral will be available only on shares which are provided as margin through Margin Pledge Mechanism. |
- The new norm necessitates the maintenance of an upfront margin at the beginning of the trade.
- For the Equity Derivatives segment, the client margins which are required to be compulsorily collected and reported include initial margin, exposure margin/ extreme loss margin and mark to market settlements.
- For BTST (Buy Today, Sell Tomorrow) trades upfront margin will be applicable on both legs (i.e., Buy and Sell).
Besides upfront margin requirements, the rule of peak margin reporting has commenced from 1st December 2020 apart from the end-of-the-day margin check, which captures the highest open position of the trader on a given day.
This means a trader necessarily will have to maintain an upfront margin without fail else a penalty will be imposed.
The best way to remain safe from any kind of penalty in margin trade facility, investors should contact their brokers to know about margins while executing a trade.
We at Bajaj Financial Securities Limited are committed to providing adequate facilities to our customers in their Stock Market investment journey. With the new rules coming into the picture, we are prepared to support our customers with instant liquidity requirements through Margin Trade Funding at one of the lowest rates in the industry.
Bajaj Financial Securities is accredited with a corporate credit rating of CCCR AAA/ Stable by CRISIL – depicting a strong liquidity position and its ability to withstand difficult economic conditions.
Toopen Demat and Trading Accountwith us, you can visit the account opening form and complete it in less than 10 minutes.
