What is Margin Trading?

Have you ever missed a good trading opportunity just because you were low on funds at that moment? What if you could leverage 4x of your buying power and seal that trading opportunity in your favor? Yes, it is possible with Margin Trading. Margin trading is trading in the securities market with borrowed resources – funds or securities. As margin trading provides a facility for investors to trade in the market with the margin money, it essentially is a leverage mechanism.  Margin Trading in securities is supported by the borrowing facility for funds and securities. Investors must put in a margin (good faith deposit) with brokers.

Value drivers of Margin Trading

• Availability of the buyer and seller in the system ensures liquidity in the system, which is essential for any market to function across the globe.
• As margin trading can be done on both sides, i.e., buy and sell, it helps to increase demand for and supply of securities and funds in the market, which contributes towards better liquidity and smooth price formation of securities.
• Margin trading also facilitates price alignment across the markets by facilitating arbitrage.

From the above points, we can say that margin trading performs a vital function in any securities market and improves the efficiency and effectiveness of the whole system.

Amplification effect with Margin Trading

Margin Trading enables investors to buy/sell more and thus increases their profits if the prices move on expected lines. But, on the other hand, it also amplifies the loss if the prices behave contrary to expectations. This amplification effect emanating from the leveraged nature of the transaction is the primary motivation for a client to undertake margin trading. For example, an investor buys ₹ 1000 worth of securities with his own money of ₹ 250 (margin of 25%) and borrowed money of ₹ 750. If the security price goes up by 10%, he will earn a return of 20%. But, conversely, if the price falls by 10%, he will lose 20%. Thus margin trading exposes a client to the potential of higher gains/losses.

Advantages of Margin Trading

• Margin Trading is ideal for those investors who are looking to benefit from the price movement in the short-term but do not have sufficient funds in hand for investing.
• Making use of securities lying in portfolio/Demat account as collateral
• Allows the investors to maximize the returns on the capital invested
• Enhances the buying power of the investors.
• Monitored by the regulator and exchanges.

Risks associated with Margin Trading

• Investor is exposed to potential of higher losses as much as higher gains
• In a falling market, an investor may lose more money than he has invested.
• If the value of securities purchased on margin falls, investors have to provide additional funds to avoid the forced sale of the securities.
• Investors have to maintain a minimum balance in their MTF account all the time. Investors may have to deposit additional cash on short notice to cover market losses or to maintain a minimum balance.
• Brokers have the right to sell some or all of the securities at the current price without consulting the client to pay off the debt. The current price may not be the best price at which an investor would have liked to sell.

If you wish to leverage your position in the market through margin trading, you can do so with the Margin Trading Facility (MTF) of Angel One.

What is a Margin Trading Facility (MTF)?

Margin Trading Facility is a facility that allows investors to buy a stock by paying a fraction of the total transaction value. The broker (such as Angel One) funds the balance amount. You can increase your buying power up to 4x via MTF. For instance, Your Account Balance = ₹ 25,000 MTF gives you up to 4x buying power = ₹ 1,00,000 (25,000 x 4) Thus, your enhanced Buying Capacity is now = ₹ 1,25,000 This means you can still trade up to ₹ 1,25,000 even when you only have ₹ 25,000 in your account. How awesome is that? However, you must ensure you have the required margin in your account before getting MTF. So, what is the margin required? Margin required is the amount you need to pay initially to buy stocks under margin products. The margin amount can be paid either in the form of Cash or Non-Cash Collateral. You can hold your positions under MTF as long as you maintain the required margin in your account.

Dos and Don’ts to make the most of Margin Trading

• Don’t forget that margin investing is akin to borrowing a loan, and you are liable to pay interest on it.
• Don’t ignore the margin shortfall. As margin Trading exposes you to high losses and high profits, you have to ensure that you have sufficient balance to meet the margin if the market turns unfavorable towards you.
• Trade wisely. Opt for Margin Trading after doing your homework and ensuring that the trade suits you.

Investors must weigh the risk-return portfolio and understand the risks before entering into Margin Trading. It is prudent that one should not get overboard with leveraged trading, ignoring the risks.

Types of margins

Margins are calculated in different ways on the cash market segment of stock exchanges. These methods include Value at Risk (VaR), Extreme Loss and Mark to Market margins.

• VaR margin: This is the most common method used. Here, we estimate the probability of loss based on historical price trends and volatility of the stock. It covers the most considerable percentage loss that can be incurred by an investor for shares on a single day with a 99 percent confidence level.
• Extreme Loss margin: This is a margin that covers expected losses in situations that lie outside the coverage of the VaR margin.
• Mark-to-Market margin: MTM is calculated on all open positions at the end of the trading day by comparing transaction price with the closing price of the share for the day.

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