Introduction
Margin trading is lending money from the broker to buy a stock from the share market. The investor is eligible to buy more stocks than he can currently afford. This procedure allows the investors to purchase shares at the marginal value compared to their actual value. The brokers provide such a trading margin in the stock market that offers customers cash to buy stocks. This margin offered can be settled at a later stage when the investors of the share market square off their position.
On the other hand, margin funding is a short-term loan facility that the investors acquire at a fixed rate of interest to fill the gap they face while trading in options and futures and while buying stocks. The investors who take the fund pay an interest amount to the lender for purchasing shares or trades. An investor can communicate with the relationship manager of the security account or the brokerage where he has a Demat account and provide him with the shortfall fund. Also, he can select this mode of funding from where he is trading while placing an order for the shares.
This trading model allows investors to improve their market results as they can earn a higher profit for every successful trade. Also, every investor must remember that margin funding is a risky investment mode. It is because, in margin funding, you can earn a profit only when your total profit from purchasing the shares is higher than the margin amount. Though this mode is available easily, you must learn all the rules and guidelines before investing through the margin funding mode of investment in the stock market. Well, in this article, we are going to know more about what margin funding is and its other functionalities.
What is Margin Trading?
Margin Trading is a method where you need to pay a marginal value of the actual value of the stocks to buy them. This margin for the stocks is paid either in cash or in the form of shares as a security. Your account broker is responsible for funding the margin trading transactions. This mode of trading is a do-or-die situation. Either you can make a good profit from the trades, or you will cause a loss.
For margin trading, you will need a margin account in the securities. This account is separate from the cash balance account, which the customers mostly open when they appear in the trading field. All the securities in your margin account, be it bonds or stocks, are considered collateral for a margin loan. If you fail to meet the requirements of your margin call by depositing added assets, your bank lender might sell some of your shares or all of your investments unless the required equity ratio is fulfilled.
The maintenance requirement of the shares in margin trade funding varies from broker to broker. It is the ratio between the amount of money you accept from the lender and your holdings’ equity. In short, it is the sum of money you can borrow from the broker for every dollar you deposit in your margin account. The rate of interest your broker charges on the margin loans can also vary from time to time, depending on your broker or the bank where you have your Demat and margin account. When availing margin funding facilities, make sure to assess all its pros and cons.
How to use Margin Trading?
To avail margin trading facility, you must have a margin account with your broker. This margin varies from broker to broker. You need to pay a certain amount of money while opening your margin trading fund account. You are required to maintain this minimum balance every time. Your traded shares are squared off if you cannot support the minimum balance. The squaring-off position is compulsory after every trading session. Before opening a margin trading account, you must also know how to use margin trading.
Once you open a margin trade funding account with your lender, your broker will release the funds you can utilise to buy shares of your choice in your desired quantities. The amount disbursed by the broker is a loan offered against cash collateral or the purchased securities. For example, you, an investor, want to purchase shares worth rupees 100,000, but you do not possess the entire amount.
However, you can have a portion of the entire amount for purchasing the shares. This amount used for buying a portion of the shares is called margin. Suppose the margin, in this case, was 20% of the total amount. Then, you will have to pay 20,000 to your broker before purchasing the shares, while the lender will provide the rest of the 80,000 rupees. The investor will also have to pay the interest designated by the bank to the lender for acquiring the margin amount.
However, you should not always opt for using margin trading every time. Just like the method of purchasing shares is profitable, it is also very risky. If you cannot profit from the number of shares you buy, you will incur a heavy loss. Try to meet the margin call whenever you are utilising the margin trading mode for buying shares. For long-term share purchases, go for standard methods. If you are willing to gain short-term profits, then you can choose this method of buying shares.
There are different types of margins in the stock market, including Initial/Daily margin, gross exposure margin, market-to-market margin, extraordinary margin, Ad hoc margin, and volatility margin. Let us know more about each of them. Also, there are some margin requirements that you must know before investing in margin trading.
The gross exposure margin is payable on the regular outstanding script-wise place. The exchange from where you trade asks the lender to have some securities in the account available in cash, shares or bank guarantee to safeguard against any payment default for the positions acquired on a particular day. Gross exposure margins are usually paid in advance before the transactions are done.
At the last of each trading day, the lenders are required to gather the margins to be paid against the open positions either on the sell-side or on the buy-side from its customers. The securities collect the daily margins to protect their eventualities that might take place between two trading days.
In the derivative field, both the seller and the buyer have to place an initial margin before opening the day of financial transactions. The margin is calculated after considering all the changes in the index’s daily price over a period, be it a year or more.
Special margins are imposed on the shares that show abnormal movements in volume or price. It is a recorded measure to measure the speculative activity in a specified script. At the BSE, the margin levels range from 25% to 40%. This particularly depends on the sharpness of the share volume or price movement.
Market-to-market margin is the deposit additional amount that the seller or the buyer has to pay when the market price of a share falls below the transaction price or vice versa. The margin for the share is calculated on the particular day’s closing price and the previous day’s closing price. This margin mode is primarily applicable in the futures and options segment.
A volatility margin is imposed on the shares to check abnormal movement on intraday transactions for a specified share or scrip. The objective is to ensure the sellers and buyers respect their commitments even if there are huge swings in the stock prices.
This margin mode is calculated by determining the difference between the highest and lowest prices over a 45-day transaction cycle and comparing it with the lowest price during that time. The margin is paid in the form of Demat shares or cash.
Ad hoc margin is prescribed by SEBI levied on the brokers with overall high positions or some illiquid stocks.
It is constantly prescribed to check the maintenance margin when investing in stocks through the margin mode of transaction.
Other uses of margins
Other products apart from the stocks can also be purchased on margin. The maintenance and initial margins will vary with other financial products. Regulatory bodies and the exchanges set minimum margin requirements. Although, there are lenders who can increase this margin requirement. Therefore, it means that the margin can vary with brokers. The initial margin required for the products is much less than that of the stocks. While the stock investors give 50% of the trade value, future traders must provide 10% of the trade value or less.
In the case of the standard mode of trading; you can buy a limited number of stocks if you have a fixed credit. In margin trading, you can buy more shares with more money. Although there are risks involved, you will have a heavy sum of money for investment. The lender will offer you more money, and with it, you can buy more of the required shares of your choice.
Since you will have enough money to trade in the market, you can diversify your portfolio according to your requirements and add more shares of your choice. All you need is to pay a portion of money at the beginning and later pay interest for that sum of money to the broker. But before doing so, remember to assess all the risks involved in margin trading. Because, in the margin, you might make a profit or incur a loss too.
If your options trading account and margin account is approved; you can also place advance options through the securities and exchange where you have a Demat account. It includes uncovered options on equities, butterflies, ETFs, indexes and spreads.
If you are investing in the market in the form of margin trading, you can expect short-term profit generation. You need to invest in volatile stocks that show better fluctuations than those designed for the long term. But before that, you need to determine the stocks for investing through margin in the stock market.
Moreover, you can also go for mutual funds if you choose margin funding because, at that time, you will have enough funds in your hand for investing.
Why choose margin trading?
Several points justify why investors should choose margin trading for investing in the stock markets.
Margin funding in the stock market is a mode of investment that will allow you to leverage assets and funds. Shares purchased through margin trading can improve your returns due to leverage. Depending on the size and the quantity of the securities you possess, the return on investments can be maximised with proper investment and planning.
Margin trading in the share market can also gain profits from a decline. Investors can use the margin trading method to gain profits by leveraging the short-selling approach. If the investors feel that there is a decline in the price of a share on a particular day, they can short sell the shares of a company through the margin trade funding process at a higher price.
Also, they can place an order to purchase those scripts when it hits a lower price on the same day. The difference observed between the buying and selling prices is the profit gained, and the leverage mode can multiply your return on investments.
The most advantageous thing in a margin funding facility is you can trade on the assets at any point in time without thinking about additional documentation and forms. Since the regulations have been removed to provide shares on securities, the margin trading facility allows the investors to leverage lone shares in their portfolio as collateral and make huge profits from them. The mode of using securities for obtaining additional margin can be performed online.
While margin trading is attractive and lucrative for the investors due to the leverage offered, you must remember that the chances of making a loss are equally higher than the chances of making profits. During adverse price movements of shares, you can also lose funds along with shares or assets. It is advised to gather relevant information regarding how to use margin trading before investing in the share market through the margin funding procedure.
The mode of margin funding is a viable process for improving and enhancing the return on investments due to the advantage of leverage. However, every share market investor must remember that a stock market is highly volatile and that leverage positions can make things riskier. Therefore, it is essential to gather appropriate knowledge and understanding before venturing into futures, options trading, and other products.
It increases the purchasing power of an investor. Due to uncalculated investments, investing in margin trading can also lead to magnified losses if things are not in your favour. Know about the margin requirement before investing in a margin trading facility.
Margin trading facility can be used by everyone active in the national stock exchange, the Bombay stock exchange, or any other securities. However, margin trading is not available for the NRI people.
The interest rate for margin trading is the same as that of the stock exchange. However, in some cases, it might vary from broker to broker.
Yes, you are eligible to transfer market stocks towards the initial margin in the form of group 1 securities or cash.
Buying power is reflected in the account balance, which is the maximum amount of money you can use to purchase shares in securities at that point. The buying power value is determined by summing up the marginal securities' total cash and loan value.
Maintaining the margin allows every customer to carry a cash delivery position. The margin can be converted to the form of cash equivalent or stocks.
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