Margin trading is a facility offered by brokers whereby you can buy shares by paying only a portion of the total value initially. The balance is taken on loan from the broker on which you need to maintain a margin (a combination of cash and securities). This, in turn, gives you leverage and enables you to take larger positions than your operating capital would allow.
How margin requirements work
Margin trading is regulated by SEBI in India, and the minimum margin will be 25% of the value of the trade, but it can be different depending on the stock. You can use cash to fund or as margin. Your broker will call a margin when the stock goes in the wrong direction and your margin balance falls below the limit, and it will require you to build up funds quickly.
Interest on borrowed funds
When you're margin trading, borrowed funds aren't free. Brokers do pay interest, typically between 8% and 18% annually based on the broker and loan amount. The interest fees can significantly reduce your profits or make your losses even worse when trades do not happen as anticipated. Investors must accurately calculate whether returns justify the cost of borrowing.
Risks of margin trading
The biggest margin trading risk is exaggerated losses. Though gains can be exaggerated, losses also are exaggerated, wiping out your invested capital sometimes. Your broker can force close-out of your positions when prices are moving significantly against the position to meet dues. Margin calls could be traumatizing, and failure to meet the same on time might attract automatic liquidation of collateral securities.
Regulations and eligible stocks
Not every stock can be margined. Only a list of SEBI-approved securities can be bought through margin. Brokers also have their own limitations on which stocks can be pledged, how much haircut is to be applied, and how much leverage to use. It is advisable to check your broker's specific terms beforehand.
Who may want to employ margin trading?
Margin trading is best suited to experienced investors who follow markets closely and are aware of volatility. It is very dangerous for beginners, and financial planners generally do not recommend it unless you understand risk management and are willing to accept the possibility of unexpected losses.
Key takeaway
Margin trading offers higher returns but also higher risk and costs. Before you join, you need to understand how margins, interest rates, and regulations are designed. As a short-term trader, it can be a useful weapon if used judiciously and carefully, but for retail investors in the long run, it is best to avoid such more risky investment concepts.
FAQs
1. What happens if I fail to fulfil a margin call?
If you fail to provide the required funds or securities to bring back your margin balance, your broker has the authority to sell your collateral shares or close your position. This is for the retrieval of borrowed money, typically at your loss.
2. Are intraday trades possible through margin trading?
Yes, margin trading is very commonly used for intraday positions where you borrow money to buy extra shares during the day and square off at market close. However, if you do not close out the position, you will be charged interest.
3. Is margin trading allowed to all investors?
No, you have to open a margin trading facility (MTF) account with your broker. Approval is subject to KYC verification, risk profiling, and broker discretion. Also, only SEBI-approved securities can be utilized for margin trading.
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