Know About Margin Trading: Risks and Advantages

Margin trading is a facility where you buy stocks you can’t afford. You can 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 money 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 otherwise, you suffer a loss.

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 purchase and redeem mutual fund units through mutual fund houses. Fund prices are determined only when the market closes after each working day. Because of this restriction, it is not possible to margin trade mutual funds.

Eligibility for Margin Trading

You need a margin account with the broker to avail of the margin trading facility (MTF). The margin varies across brokers. You are supposed to pay a certain sum (minimum) when opening the MTF account. You are required always to maintain a minimum balance. Your trade gets squared off if you fail to maintain the minimum balance. The squaring-off position is compulsory at the end of each trade session.

SEBI Regulations

Until last year, 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.

Features of Margin Trading

• Margin trading allows investors to leverage positions in securities 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 cash or collateral through shares.
• Margin-created positions can be carried forward up to a maximum of N+T days, where N is the number of days the position can be carried over (this varies across brokers) and T is the trading day.
• Investors wishing to use the margin trading facility should create an MTF account with their respective brokers and accept the terms and conditions, stating they know the benefits and risks involved.

Benefits of Margin Trading

• Margin trading is apt for investors who want to profit from price fluctuations over the short term but lack enough cash.
• 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. You can end up losing more than what you invested. Investors think that borrowing from brokers is simpler and that dealing with them is more straightforward than banks. But, little do they know that lending from brokers is as binding as they are with banks.

Minimum Balance: 

Always maintain a minimum balance in your margin trade account. If your balance falls below the minimum, your broker will ask you to maintain sufficient balance. If you cannot keep the minimum balance, you will be forced to sell some or all the assets to maintain the minimum balance.

Liquidation: 

Brokers can initiate actions against investors who fail to adhere to the margin trade agreement. If you fail to meet a margin call, the broker can liquidate your assets to recover the sum.

How to Use Margin Trading Facility Better

Invest Wisely: 

If you plan to invest through margin trading, you must be highly cautious. Margin trading can magnify both losses and profits. If things go well, then it’s okay. If things go against you, you will 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 Less than the Allowed Limit: 

You should refrain from borrowing the full limit. Give a try with a smaller amount upfront and see how it goes. You can continue as a margin trader if you are confident in making good profits.

Borrow for Short Durations: 

A margin is like a loan; you are liable to pay interest. Settling the margin as soon as possible is advisable so you don’t accumulate higher interest.

Conclusion

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

Invest in Direct Mutual Funds

Save taxes upto Rs 46,800, 0% commission

Start Investing Now