Margin trading and short selling both are leverage products offered to day traders. Both these have an element of borrowing in them. Leverage helps in magnifying profits. However, one must not be over-leveraged as it may cause magnified losses too. Leveraging is a great tool to improve the return on investment (RoI)
In margin trading, the trader borrows money for increased exposure to maximise profitswhile on the other hand in short selling the trader borrows specific stocks to short sell to capitalize on short-term opportunities. In both cases opening a margin trading account with a broker is necessary.
Let’s understand how margin trading and short selling works.
In margin trading, one can invest or take an exposure more than what you can otherwise invest or trade with your own money. In simple words, the broker finances your trade partly for a fee known as interest on margin financing. This helps in taking advantage of any favourable movement expected by the trader and maximising the profit on it.
Let us understand what is margin trading with an example. A trader expects the State Bank of India (SBI) to go up in the next few days based on his information and study and wants to buy 500 quantities of SBI which is trading at Rs.450. The total cost of this trade would be Rs.2,25,000 (excluding brokerage and charges). Generally, the trader must bring in at least 20 per cent from his side. In our example, he has Rs.75,000 credit in his margin trading account and doesn’t want to lose the opportunity. The trader can use his margin trading account to buy the entire 500 quantity of SBI as the balance of Rs.1,50,000 (Rs.2,25,000-Rs.75,000) will be funded or borrowed from the broker on which interest will be charged.On the T+2 day, if SBI moves up to Rs.470 as expected by the trader, he will make a quick profit. The brokerage and other charges along with interest and the funding will be deducted and the balance will be credited to the account.
Let us understand the calculations:
Buying side | ||
Purchase price of SBI (500 x Rs.450) | 2,25,000 | (Rs.75,000 is own fund) |
Brokerage and charges (0.5%) | 1,125 | |
The total cost of purchase | 2,26,125 | |
Selling side | ||
Sale proceeds of SBI (500 x Rs.470) | 2,35,000 | |
Brokerage and charges (0.5%) | 1,175 | |
Margin funding | 1,50,000 | (Rs2,25,000-75000) |
Interest on margin funding for 2 days (15% annualised) | 1,23 | ((1,50,000*15/100) *2/365) |
Net sale proceeds | 2,33,702 | |
Profit on the whole transaction | 7,577 | |
ROI | 3 % |
Short selling is a method where a trader sells first and buys later. Markets throw immense opportunities when it goes down. Those are the times one can short sell and make quick profits. The catch however here is shares should be available in your demat account that can be sold. Indian equity markets do not allow short selling in the cash market. Therefore, short selling can be done only through borrowing shares. In short selling, the trader borrows shares unlike in margin trading.
The working of short selling is similar to margin trading the only difference is that the trader borrows shares instead of money. Let us understand the process of short selling. For ease and understanding, we will take the same example of SBI. The trader wants to short sell SBI and SBI is not available in his demat. The trader uses the same margin funding account and borrows SBI shares for selling. As the stock goes down the trader buys SBI with these proceeds and makes a quick profit. On T+2 the trader gets delivery and it is credited back to the broker account.
Both margin trading and short selling have their advantages and disadvantages. The advantages are improvement in ROI due to enhanced profit with minimum own funds and the disadvantages being quick loss as well. For margin funding, one can use stocks or other liquid assets or mutual funds as collateral like fixed deposits as a pledge. Since the collaterals are pledged the cost on this is zero and only the funding from the broker will be charged for interest. Apart from this, the pledged stocks can be sold regardless of the pledge. Short selling on the other hand can be used as a tool for hedging your existing position and is also tax efficient as it will be treated as short-term capital gains.
Both margin trading and short selling are risky and active risk management is paramount. As a word of caution only experienced traders should indulge in these transactions as the loss could be too big for a novice trader.
Anybody who has a broking account and is willing to bring in margin and maintain is eligible.
One can take delivery of positions just by maintaining the margins. Margins can be bought in the form of cash, stocks or cash equivalents.
No there are no additional charges.
Dividends bonus etc. will be credited to your account.
Please note that by submitting the above mentioned details, you are authorizing TradeSmart to call and email you and also to send promotional communication even though the contact number may be registered under DND.
Please note that by submitting the above mentioned details, you are authorizing TradeSmart to call and email you and also to send promotional communication even though the contact number may be registered under DND.
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Please note that by submitting the above mentioned details, you are authorizing TradeSmart to call and email you and also to send promotional communication even though the contact number may be registered under DND.