What is Margin Trading in Stock Market: Features, Risk and Benefits

Margin trading is a stock market practice in which intraday traders place high volume trades utilizing only a small portion of their investing capital. Essentially, in margin trading, intraday traders borrow the money to buy or sell shares from the broker to place their trades and in case of profits exceeding the margin amount, the margin amount is deducted from the profit they make. In case of losses exceeding the margin, either extra amount has to be paid to the broker of the securities given to him as collaterals are lost.

In a nutshell, margin trading is buying stocks or shares you cannot afford. If you are serious about intraday trading, then you can take benefit of margin trading by opening a margin trading facility account or MTF. A trading account with the MTF requires you to maintain a minimum balance in your account. If the minimum balance is not maintained, your broker is likely to ask you to top up your margin trading account.

Until 2017, margin could only b paid to the broker in the form of cash. However, following a regulation by the Securities and Exchange Board of India (SEBI), the margin trading facility has been extended to include shares as collaterals as well. So, instead of paying cash, shares of a lower value can be paid as margin against trades to be places for shares of a higher value.

While this has made margin trading much more convenient for intraday traders, it has also affected the risk involved with intraday trading. Let’s understand its Features, risks and benefits.

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Features of Margin Trading

1. Only Authorized Brokers can Offer Margin Trading Facility

Offering margin trading is a facility which is very closely monitored by the markets regulator SEBI. Since the 2017 regulations, brokers have access to assets of the traders, which are to be used as margins. There is a possibility of brokers utilizing this margin for other purposes such as meeting their own expenses, without the knowledge of the investor or trader. This can be a harmful and unethical practice and hence, to provide margin trading facility to intraday traders stock brokers have to seek special permission from SEBI and abide by the rules of margin trading that the brokers will not use the collaterals kept as margins for any other purpose.

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2. Margin Created Position can be Carried Forward to T+N Days

This means that in some cases, trades executed using the margin facility can be closed for more than one day. This makes the margin facility useful for position and swing traders as well, who open and close their positions on different days, unlike intraday traders. The positions can be kept open for T+N days, where T refers to the day when the position has been opened and N refers to the number of days within which the position should be closed.

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3. Not All Stocks can be Bought on a Margin

Another important feature of margin trading which you need to keep in mind is that not all the stocks listed on the exchange can be traded on a margin. There are some stocks such as penny stocks or IPOs which cannot be purchased using margin as the risk associated with these is quite high.

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4. A Separate Account is Needed for Margin Trading

For availing the margin trading facility extended by brokers, traders and investors need to create a separate account, agreeing to all the terms and conditions related to maintaining such an account which often keeps cash or shares as collaterals. In case of losses, the broker reserves the right to square off the position, in case the margin provided is not sufficient. This can lead to loss of assets kept as collateral which is an inherent risk of margin trading for which you need to be prepared.

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Benefits of Margin Trading

1. Enhances Your Buying Power

Margin trading boosts the buying power of investors. If you are planning to use margin trading for intraday or BTST trades, then this facility can be greatly helpful in giving you the additional purchasing power and investing a higher amount in the markets.

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2. Increased Rate of Return on Capital Invested

When used currently in the markets for trades which turn out to be profitable, margin trading can boost your rate of return and can give you returns which are much higher than what you would have been able to achieve through regular trading. In such cases, the profit earned after the trade can be many times the actual margin amount paid to the broker.

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3. Even Shares or Securities You Own can be used as Margins

So if you do not have cash to put as margins for your trades, but you have shares in your demat account which are worth a large sum, then these shares too can be put up as margin. For example, if you want to use a margin of Rs. 5000 for placing trades but you do not have this amount in cash and instead have shares of a company worth Rs. 50000, then you can give up these shares as margin for your trades, and if the value of your profits goes above Rs. 5000, then you can get back your shares as well as the amount you earned through your trade, by paying Rs. 5000 from the profits.

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Risks involved in Margin trading

1. Minimum Balance is Required

Unlike a regular investing account or demat account, in which you can have even one or two shares kept for a longer time, a margin facility trading account requires you to maintain a minimum balance in your account at all times. Also, it is recommended to not use up the entire margin in your account for intraday trades, since a loss in the markets would then wipe out your margin and will also force you to pay additional amount to maintain the new margin as well as to cover up the losses.

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2. Losses can get Magnified

Just as these margin trading accounts offer the possibility of multifold profits in the markets, the losses incurred here can also be multifold and can lead to erosion of entire collateral amount or assets. If you want to trade on margins, then it is very important to assess as to hw uch risk you can afford to take in the markets.

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3. Your Positions can be Squared off by the Broker

If you do not have enough margins in your trading account and the losses incurred in any particular trade are increasing, then the broker will first ask you to replenish your minimum amount in the margin. If this condition is not fulfilled, then the broker can close your position without informing you.

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CONCLUSION

Utilizing the margin facility is a very tricky business and you should go for it only when you have a proper trading plan in place. Also, if you feel that your broker has misused the margin provided by you, then you can seek help before SEBI, the regulator body which keeps a strict check on any such unethical activity regarding investors’ money.

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