What is Margin
What is Margin
Usually, when you trade on the stock markets, you have to keep cash ready. You pay the money first and then buy your shares. However, you have the option of borrowing money to trade in the stock markets. This is possible through margin trade.
Here are five key things to know about what is margin:
- Margin Trading: While trading using margins, you are essentially borrowing money from your broker and conducting trades. When you borrow, you increase your ‘leverage’ or ‘exposure’. This is measured in multiples. For example, suppose you want to buy shares worth Rs 1 lakh, but you only have Rs 10,000, then you borrow the rest from the broker. This puts your margin exposure at 10 times. The amount you are eligible to borrow depends greatly on your credit history and past transactions.
- Margin Call: While trading using margins, you need to pay two amounts – the initial margin and the maintenance margin. The initial margin is the minimum amount you have to pay as part of any margin trading transaction. Consider this like the advance amount or down-payment while buying a house. Once you buy the shares though, you need to constantly maintain a percentage of the total trade amount in your account. This is called maintenance margin. Suppose you have to pay 25% of the total trade as initial margin, and then constantly maintain 20% as maintenance. For a trade worth Rs 1 lakh, you will have to pay Rs 25,000 as the initial payment and then maintain Rs 20,000 in your account. If the amount in your margin account falls below the 20% mark, a ‘margin call’ is generated. You then have to deposit an extra amount in your account to bring your margin amount up to required levels.
- Mark to Market: The requirement of maintenance margin is marked-to-market. This means, it is closely linked to the current market price of the shares. So, as and when the share price rises or falls, your maintenance margin changes. In the previous example, suppose the share price rises to Rs 105 from Rs 100 earlier, your maintenance margin also climbs to Rs 21,000. So, it is always good to ensure you have some extra money in your margin account. Otherwise, a margin call will be generated.
- Advantages: The best advantage of the trading in margins is that you can conduct high-value transactions with minimum amounts. Even if you only have a few thousand rupees in your account, you can conduct trades worth lakhs. The other advantage is that margin trading can amplify your profits. Suppose you buy shares when it is price at Rs 100. Using margins, you buy stocks worth Rs 1 lakh. The share price goes up to Rs 110. You decide to sell it, pocketing a cool profit of Rs 10,000. If you had not borrowed money, you may have been able to buy stocks worth only Rs 10,000. Your profit would then be limited to Rs 1,000 only.
- Risks: As with any market instrument, greater the potential for profit, higher are your risks. Just like how margin trading amplifies your profits, it can also increase your losses. In case your trading strategy fails, remember, you not only lose your money, but you also have to pay back the money owed to the broker. After all, margin trading increases your leverage. This is like any other debt. Moreover, you also have to pay an interest fee for the amount you borrow.
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