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Know About Margin Trading: Risks and Advantages

Updated on: May 10th, 2022


6 min read

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Margin trading is a facility under which you buy stocks that you can’t afford. You are allowed to buy stocks by paying a marginal amount of the actual value. This margin is paid either in cash or in shares as security. Margin trading can be considered leveraging positions in the market either with cash or security by investors. Your broker funds your margin trading transactions. The margin can be settled later when you square off your position. You make a profit when the profit earned is much higher than the margin, else you suffer a loss.

SEBI Regulations

Until last year, the margin trading was allowed only with cash and providing shares as collateral was not allowed. The Securities and Exchange Board of India (SEBI) recently relaxed this criterion by allowing investors to create positions under the margin trading by furnishing shares as security.

Eligibility for Margin Trading

You need to have a margin account with the broker to avail the margin trading facility (MTF). The margin varies across brokers. You are supposed to pay a certain sum (minimum) at the time of opening the MTF account. You are required to maintain a minimum balance at all times. If you fail to maintain the minimum balance, then your trade gets squared-off. The squaring-off position is compulsory at the end of each trade session.

Features of Margin Trading

  • Margin trading allows investors to leverage positions in securities that are not from the segment of derivates.
  • Only authorised brokers can offer margin trade accounts as per SEBI regulations.
  • Securities that are margin traded are pre-defined by SEBI and respective stock exchanges.
  • Investors can create positions against the margin in the form of cash or collateral through shares.
  • The margin created positions can be carried forward up to a maximum of N+T days, where N is the number of days the said position can be carried over, this varies across brokers and T is the trading days.
  • Investors wishing to utilise the margin trading facility should create an MTF account with their respective brokers by accepting the terms and conditions that states they are aware of the benefits and risks involved.

Benefits of Margin Trading

  • Margin trading is apt for those investors looking at encashing on the price fluctuations over a short-term but do not enough cash in hand.
  • Securities in the portfolio or demat account can be utilised as a security/collateral.
  • MTF improves the rate of return on the capital invested.
  • MTF enhance investors’ purchasing power.
  • The market watchdog SEBI and stock exchanges continuously monitor the margin trade facility.

Risks Involved in Margin Trading

  • Magnified Losses: If the margin can help investors magnify profits, it can also magnify losses. In fact, you can end up losing more than what you invested. Investors think that borrowing from brokers is simpler and dealing with them is easier than banks. But, little do they know that borrowing from brokers is as binding as they are with banks.
  • Minimum Balance: You are supposed to maintain a minimum balance in your margin trade account at all times. If your balance falls below the minimum balance, then your broker would ask you to maintain sufficient balance. If you are unable to maintain the minimum balance, then you would be forced to sell some or all the assets to maintain the minimum balance.
  • Liquidation: Brokers have the right to initiate actions against the investors if they fail to keep up to the margin trade agreement. If you fail to meet a margin call, then the broker can liquidate your assets to recover the sum.

Margin Trading in Mutual Funds

Mutual fund units cannot be bought through margin trading because of their trade mechanism. Mutual fund units are not sold like stocks. Investors buy and redeem mutual fund units through mutual fund houses. Fund prices are determined only when the market closes after each working day. It is because of this restriction that it is not possible to margin trade mutual funds.

Good Margin Trade Practices

  • Invest Wisely: If you are planning to invest through margin trading, then you have to be extremely cautious. Margin trading can magnify both losses and profits. If things go well, then it’s fine. If things go against you, then you would be in a real spot of bother. You should invest through margin trading only if you have sufficient cash to withstand a momentary move against your position and meet the margin call.
  • Borrowing Lesser than the Allowed Limit: You should refrain from borrowing the full allowed limit. Give a try with a smaller amount upfront and see how it goes. If you are confident in making good profits, then you can continue to be margin trade.
  • Borrow for Short Durations: Margin is like a loan, and you are liable to pay interest on it. It’s advisable to settle the margin at the earliest so that you don’t accumulate higher interest on it.

Margin trading increases investors’ purchasing power. However, it can lead to magnified losses if things don’t go in your way. You have to be extremely careful when trading marginally.

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