Margin trading refers to the process of borrowing money from your broker in order to leverage your available capital to trade in stocks.
Remember, stocks and options can be traded in either cash or margin account, short sales of stocks can only be traded in a margin account.
To start margin trading you need to have a margin account with a brokerage firm. This account will allow you to borrow funds from the brokerage firm to finance all or part of your trade.
When you do margin trading, there will be a margin requirement, meaning you must have a certain amount of cash, securities on deposit with the brokerage firm to be used as collateral. Certain percentage of your deposit will be allowed as a margin for trading or investing. This is called margin buying power.
In simple words, when you are using margin, you are using leverage to trade, meaning you are trading with borrowed money. It’s a loan given to you by your stockbroker. Whatever amount you deposit into your account, the broker will match your deposit with a loan of equal value or more based on the facility they provide to you.
Margin in intraday trading
When you trade in equity and square the position off before the end of the day, it is called intraday equity trading.
Since you don’t carry the position overnight, brokers provide you a margin or leverage of between 5 to 20 times of your deposit on most of the stocks to trade for intraday.
This leverage is decided based on the risk and volatility of the stock.
Before taking a trade, brokers will give you the option to choose whether the trade is intraday or an overnight position.
You have to square off your intraday position on the same day, or else, the broker will square off between 3:15 PM to 3:20 PM. For automatic square off, they might charge you a fee per trade.
You can also convert the position from intraday to delivery by providing additional margin as required by the broker. When you buy stock and hold it overnight, it is called a delivery trade.
For overnight trading or delivery margin rules of the brokerage firm are different.
Most of the discount brokers do not provide any leverage when you are executing delivery. This means, if you want to buy Rs. 10,000 of stocks as delivery, you will need Rs. 10,000 in your account. Likewise, if you want to sell Rs. 10,000 of stocks by selecting delivery, then you will need to have these shares in your demat account mapped to the trading account.
You will get margin trading facility for overnight positions with a full service broker.
Margin requirement gets calculated based on the kind of stock you trade and your deposit with the broker. If the stock is very volatile, then you may or may not get margin trading facility.
If you want to do margin trading, then before getting into it, call your broker to know the exact rules. In addition, ask the interest rate they charge for margin. Just like any bank or financial institutions, your broker charges interest on it.
In order to support the risk associated with intraday or day trading, margin rules are specified by brokers based on our laws.
Most of these margin requirements are calculated based on the customer’s securities position at the end of the day.
Maintenance margin
Maintenance margin is the minimum amount that you must be maintaining in your margin account. Once a trader or investor has borrowed funds to buy or sell stock, the minimum required level of deposit in the broker’s account should be maintained.
In India, margin requirements are defined based on the stock you trade. Brokerage may demand higher maintenance of margin based on market and stock volatility.
You can find margin requirements with respect to stock you trade from your broker.
Why margin trading is popular
There can be two main reasons why we have margin trading facilities.
First, it gives extra buying power to experienced traders who know the kind of risk he/she is taking for the trade. Therefore, they prefer to make more money than the interest on the loan cost them for the trade. In other words, margin trading allows customers to leverage their capital to increase profits when the market moves in their favour.
Second, the only way for short selling is to open a margin account. In a bear market, short selling can give you profit. Remember, short selling is not for novice traders.
When the market falls, the stock you are holding on margin may also fall, you lose twice as much money as you would if you were playing with your own cash or deposit. The simple reason is you pay interest as long as you haven’t squared off your position in addition to the trading loss. As a beginner, you should forget you have a margin account and trade only your original deposit.
Each brokerage firm maintains their own margin policies. You need to go through these policies before trading in stocks and options.
Remember, if the market moves against you, then margin trading might double your losses.
What is Margin call?
When the position goes against the trader and their deposit in the account falls below the maintenance margin, the broker will initiate a “margin call”.
If you don’t follow the rules, you will get the margin call, meaning you must add enough money to your account to meet the margin requirement or else further action will be taken. If you don’t add enough funds to your account, then the brokerage firm might sell your securities in order to ensure that the margin call is met.
Margin call is a clear warning signal that you are losing money. If the trade does not work in your favour, the losses can be accelerated substantially to damage your account.
Many experts recommend not to go for margin trading until you have gained enough knowledge and experience to trade or invest in the stock market. It’s always recommended to buy what you can afford.
When you receive a margin call, you need to deposit more cash to your account to cover the shortage. If you don’t provide sufficient cash to cover the margin requirements, then the broker might liquidate your position in order to cover an outstanding margin call.
In addition to the disclaimer below, please note, this article is not intended to provide investing or trading advice. Trading in the stock market and in other securities entails varying degrees of risk, and can result in loss of capital. Most investors and traders lose money. Readers seeking to engage in trading and/or investing should seek out extensive education on the topic and help of professionals.
