What is margin trading?
The investors have a lot of scope going into the stock market for trading. So those who are starting out in the stock market need to understand what is margin trading. Margin trading simply refers to buying on margin (funds) that is the investor borrowing from broker.
The investor uses this money to buy different stocks. If you are wondering what is margin trading, then it is just like borrowing a loan from a bank (here broker), and you use that money to buy different stocks. Then from the profit you make from this borrowed money I will help you to pay back the loan in near future.
So you have a basic idea about what is margin trading, now let us know about margin trading in stock market.
Margin Trading in stock market
Before understanding about Margin Trading, you should know about Margin. So margin is the amount of the equity that the investors have available in their account.
There are so many questions like, should the investor do margin trading in stock market? By doing margin trading in stock market the investors can buy more stocks, share or contracts. Among all the other services your broker may offer you margin trading opportunities. The margin is decided by the broker. So the investor can pay an amount for a few shares and buy more. The reason for this is that investors would get a chance to buy more stock with the loan or credit called Margin Trading that the broker offers. The margin trading is mostly offered by brokers for intraday trading. But some of the brokers also provide margin trading in the share market for trading in position.
Margin trading is also known in the Indian market as intraday trading.
But the brokers have their limitations as they cannot provide margin trading in share market for a long period. So for a short term, you can take this benefit and profit from the opportunity to pay it back over a decided period of time.
The margin trading in share market also depends upon the company and the stock of that company. And no margin in stock market offered by the brokers for two or more different companies are the same. The margin in stock market differs because of this reason.
If there is a company with a good market reputation then the margin trading in share market provided by the broker will be higher, that means the investors or shareholders can buy more shares with the margin offered.
Types of margin in stock market
The investors need to familiarize themselves with different types of margin in stock market as knowing less about the margins may lead to financial loss. Normally the investors go into taking margin from its broker as it benefits them greatly to buy more shares but that happens if the price of the stock they invest in rises. If the price of the stocks increases then it will help the investors to pay the borrowed funds that is margin to their broker.
The price of the stocks may also fall after the optimistic investors invest with future profits in mind. So this becomes a loss for them. This loss is borne by the investors. So they have to pay the margin borrowed from the investors back and also bear the loss of share price. So the loss becomes huge for the investors.
There are different types of margin in stock market and learning about them may help the investors in deciding which one they can choose from their broker. Basically, there are several types of margin in the stock market and they are as follows,
Initial Margin: The investor is required to pay some percentage of the amount when he uses a margin account. This amount acts as a backup for the broker when the price falls occur and causes the losses to the broker as well as investors then this amount becomes useful. It is essentially a collateral that can be cash, securities or in some cases open-ended mutual funds. As per the federal regulations the minimum initial margin has been set to 50% of the price of security that an investor purchases. This is also called Daily Margin which means that this margin brokers receive daily.
Maintenance Margin: In Maintenance Margin, the investor needs to maintain minimum margin with the broker. If you fail to maintain it, the brokers may liquidate the position you have by doing a margin call.
Gross Exposure Margin: The investors need to pay Gross Exposure Margin on a daily basis for each stock’s outstanding positions. In this exchange, the brokers need to collect the required securities either in cash, shares, or bank guarantee. This is done against the default for the payment of the positions taken on that same day.
Special Margin: The Special Margin is somewhere between 25 to 50 percentages. There are chances the price of the stocks may change unexpectedly. The reason for these abnormal movements is many speculations in the market about the stock. The price variability is the major reason for this.
Variation margin: Variation margin needs to be deposited in your daily margin account. This will bring you below the maintenance margin after you have gone through losses. To get variation margin you need to to subtract maintenance margin from daily/initial margin
Ad Hoc margin: This margin is directly collected from the security exchange board from the investor having larger positions considering the risk. This is calculated on overall basis specific volatile low price stocks
Mark to market margin: The mark to market margin is the difference between the closing of the current day and the closing of the previous day. This is the difference amount that needs to be paid when the price of a stock falls below the buyer's transaction or increases above the seller's transaction price.
Volatility Margin: During a cycle of 45 days, there are many transactions that occur and there will be a transaction with the highest price and there will be a transaction with the lowest price. To find the volatility margin, the investor needs to find the difference between these prices.
So the above are the types of margin in stock market. All you need to do is go to your broker and ask about the rate or charges at which he provides the margin trading services.
Let us understand margin trading with a simple yet effective example.
The investor can pay INR 200 for a ABC Company’s share and with the opportunity - margin in stock market offered by the broker that may let him buy stocks of INR 2000. This shows that the broker offers 10 times margin on ABC Company’s shares. So this is how margin trading in stock market works.
Margin trading in indian stock market
Margin trading in Indian stock market plays an important role as the investors with limited money can avail such benefits of buying more shares at manageable risk. Margin trading in Indian stock market is a great alternative to the traditional method of trading. But in stock market nothing is without risk and margin trading in Indian stock market is no exception. You need to be aware about the charges of the broker because ultimately those you have to pay to keep the position in the stock.
The brokers earn their fair brokerage over the total value of the stock offered to you. The brokerage charges you need to confirm with your broker. The broker already has some percentage in the stock offered to you. The reason for the brokers to offer you margin is because the broker can earn more brokerage on the stock offered to you.
Margin trading increases the purchasing power of the investors. So the investors are using their brokers’ money to buy the company’s shares in the market.
The margin call only happens if the margin account falls below the broker's required amount. So to keep the stocks, the investors need to maintain either funds or securities requested by the broker.
The premium of option contracts is paid by the buyers that amounts to the equal value of the premium of an option multiplied by the quantity of the purchased options.
If you cannot cover Margin Call, the broker can close open positions to bring the margin account to its minimum value. The broker does not require your permission or approval for taking this action.