JUN 4, 2020
By : ATHUL RAJEEV, VENTESKRAFT.
In the stock market, margin trading refers to the process whereby individual investors buy more stocks than they can afford to. Margin trading also refers to intraday trading in India and various stock brokers provide this service. Margin trading involves buying and selling of securities in one single session. Over time, various brokerages have relaxed the approach on time duration.
The process requires an investor to speculate or guess the stock movement in a particular session. It’s an easy way of making a fast buck. With the advent of electronic stock exchanges, the once specialized field is now accessible to even small traders. A margin account provides you the resources to buy more quantities of a stock than you can afford at any point of time. For this purpose, the broker would lend the money to buy shares and keep them as collateral.
In order to trade with a margin account, you are first required to place a request with your broker to open a margin account. This requires you to pay a certain amount of money upfront to the broker in cash, which is called the minimum margin. This would help the broker recover some money by squaring off, should the trader lose the bet and fail to recuperate the money.
Once the account is open, you are required to pay an initial margin (IM). Which is a certain percentage of the total traded value pre-determined by the broker. Before you start trading, you need to remember three important steps. First, you need to maintain the minimum margin (MM) through the session. Because on a very volatile day, the stock price can fall more than one had anticipated.
If a Tata Steel stock priced at Rs 400 falls 4.25 per cent and the IM and MM.They are 8 per cent and 4 per cent of the total value of the shares bought. Respectively, then the trade-off 8%-4.25%=3.75% will be less than the MM. In this case, you will either have to give more money to the broker to maintain the margin or the trade will get squared off automatically by the broker.
Secondly, you need to square off your position at the end of every trading session. If you have bought shares, you have to sell them. And if you have sold shares, you will have to buy them at the end of the session.
Thirdly, convert it into a delivery order after trade, in which case you will have to keep the cash ready to buy all the shares. You had bought during the session and to pay the broker’s fees and additional charges.
If even one of these steps is missed, the broker will automatically square off the position in the market.
Risks Associated with Margin Trading
Even though investors can magnify their profits from margin trading, it can also pose to be a risk for several reasons.
- High risks –
The risks associated with margin trading are high as investors can end up losing more than they had invested.
- Minimum balance maintenance –
Investors have to maintain a minimum balance in their MTF account at all times. If the balance falls below what is mandated by the broker, the investor will be forced to deposit more cash or sell off some of the stocks in order to maintain the minimum balance.
- Risks of liquidation –
Brokers have the right to liquidate assets in the MTF to recover their losses if investors fail to uphold their end of the margin trade agreement.
Advantages of Margin Trading
The benefits imparted through this trading process are :
- Ideal for short term profit generation –
It is ideal for investors looking to profit from short term price fluctuations in the stock market, but not having enough cash in hand for investing.
- Leverage market position –
This trading process helps investors to leverage their position in securities that are not from the derivatives sector.
- Maximize returns –
It allows investors to maximize the rate of return on the capital they invest.
- Utilize securities as collateral –
Investors can utilize the securities in their demat account or their investment portfolio as collateral for margin trading.
- Regulated under SEBI –
The facility of margin trade is under constant supervision of stock exchanges and SEBI.
However, investors can minimize chances of losses from this trading by exercising the following practices –
- Since investing through margin trading is akin to borrowing an advance, investors are liable to pay a certain percentage of interest on it. That is why it is crucial for investors to try and settle the margin at the earliest to avoid accumulating a large interest on it.
- Investors should be careful and refrain from borrowing the maximum amount allowed. It is best to continue margin trading once investors are confident about making profits.
- Since this trading process can bear both high profit and loss, investors should ensure that they have sufficient cash to meet the margin, should the market become unfavourable for them.
Margin trading in India was allowed only through cash, while providing shares as collateral was restricted. However, under fresh regulations put forth by SEBI in 2018. Investors can leverage their market position through margin trading by providing shares as security.
Further, margin accounts can be offered only by authorized brokers, according to regulations put forth by SEBI.