what is Margin?
The amount of money that an investor must deposit with their broker or exchange to cover the credit risk that the holder offers to the broker or exchange is referred to as margin. When an investor borrows money from a broker to buy financial instruments, borrows money to sell them short, or gets into a derivative transaction, he or she is assuming credit risk.
When an investor purchases an asset on margin, the remaining funds are borrowed from a broker. The first payment made to the broker for the asset is referred to as buying on margin, and the investor utilises the marginable securities in their brokerage account as collateral.
In a wide commercial setting, the margin is the difference between the selling price of a product or service and the cost of production, also known as the profit-to-revenue ratio. The portion of an adjustable-rate mortgage (ARM) interest rate that is added to the adjustment-index rate is referred to as margin.
- The difference between the entire value of an investment and the loan amount is the margin, which is money borrowed from a broker to purchase an investment.
- Margin trading meaning is the process of trading a financial asset with borrowed money from a broker that serves as collateral for the broker’s loan.
- A margin account is a form of brokerage account in which an investor can use current cash or securities as collateral for a loan.
- The leverage of the margin will most likely exacerbate both gains and losses. In the case of a loss, a margin call may compel your broker to liquidate securities without your authorization.
More About Margin!
The amount of equity in a brokerage account is referred to as margin. Using margin money borrowed from a broker to acquire securities is referred to as “to margin” or “buying on margin.” To do so, you’ll need a margin account rather than a regular brokerage account. A margin account is a brokerage account in which the broker lends the investor margin money so that they can acquire more securities than they could with their existing account balance.
When you buy securities on margin, you’re effectively utilising the cash or securities already in your account as collateral for a loan. The interest rate on the collateralized loan is fixed and must be paid on a regular basis. Because the investor is using borrowed funds, or leverage, both the losses and gains will be increased. Margin investing can be advantageous when an investor anticipates to earn a higher rate of return on their investment than they are paying in interest on a loan.
For example, if your margin account’s initial margin requirement is 60% and you wish to buy Rs.2 lac worth of stocks, your margin would be Rs. 1,20,000 lac, and you may borrow the remaining from the broker.
What is Buying on Margin?
Buying on margin is when you borrow money from a broker to buy stock. It’s similar to getting a loan from your broker. Margin trading allows you to buy more shares than you would otherwise be able to. A margin account is required to trade on margin. This is not the same as a regular cash account, where you can trade with the margin money in it.
To start a margin account, your broker is obligated by law to acquire your consent. The margin account could be included in your usual account opening agreement or it could be a different agreement entirely. A margin account requires a minimum investment of $2,000 (Rs. 1,50,588), though some brokerages may require more.
You can borrow up to 50% of the stock’s purchase price after the account is open and running. The initial margin is the amount of money you put down on the transaction. It’s critical to understand that you don’t have to margin all the way to 50%. You can take out a smaller loan, say 10% or 25%. You should be informed that certain brokerages demand a deposit of more than 50% of the transaction price.
You can keep your loan for as long as you want as long as you meet your commitments, such as paying interest on borrowed funds on time. When you sell a stock in a margin account, the proceeds are applied to the loan repayment until it is completely paid off.
There’s also a maintenance margin requirement, which is the minimum account balance you must maintain before your broker will force you to deposit more funds or sell stock to pay off your loan. A margin call is what happens when this happens. A margin call is essentially a request from your brokerage for you to deposit funds or cancel positions in order to restore your account to the appropriate level. If you fail to meet the margin requirement, your brokerage firm may cancel any open positions in order to restore the account to its minimal value. Your brokerage firm has the authority to liquidate positions without your permission and can pick which ones to liquidate.
You may also be charged a commission by your brokerage firm for the transaction. Your brokerage business may liquidate enough shares or contracts to exceed the initial margin requirement, and you are responsible for any losses incurred during this process.
Things to Consider
Because margin is a type of borrowing money, it has expenses, and the account’s marginable securities serve as collateral. The interest you must pay on your loan is the most significant expenditure. Unless you choose to make payments, interest will be charged to your account. As interest charges accrue against you, your debt level rises over time. As debt grows, so do the interest charges, and so on. As a result, margin purchasing is primarily employed for short-term investments. The higher the return required to break even on an investment, the longer you keep it. If you maintain an investment on margin for an extended period of time, the chances are stacked against you making a profit.
Not all stocks are eligible for margin purchases. The Federal Reserve Board controls which stocks can be leveraged. Because of the day-to-day risks inherent with penny stocks, over-the-counter Bulletin Board (OTCBB) securities, and initial public offerings (IPOs), brokers will generally not enable consumers to purchase these types of stocks on margin. Individual brokerages can also refuse to margin particular stocks, so check with them to see whether your margin account is restricted.
Example of Buying Power
Assume you’ve put Rs. 8 lac into your margin account. Because you contributed half of the purchase price, you now have Rs. 16 lac in purchasing power. Then, if you buy Rs. 4 lac in shares, you’ll still have Rs. 12 lac in purchasing power. You don’t have to use your margin because you have enough cash to cover this purchase. Only when you buy stocks worth more than Rs. 8 lac do you start borrowing money.
It’s worth noting that the buying power of a margin account fluctuates daily, depending on the price movement of the account’s marginable securities.
Know about uses of Margin!
- Accounting Margin: Margin is a term used in corporate accounting to describe the difference between revenue and expenses, and it is used to measure gross profit margins, operating margins, and net profit margins.
- Mortgage Lending Margin: For a set length of time, adjustable-rate mortgages (ARMs) have a fixed interest rate, after which the rate increases. Consider a mortgage with a 4% margin and is indexed to the Treasury Index to better comprehend this. If the Treasury Index is 6%, the mortgage interest rate is 6% plus the 4% margin, for a total of 10%.
Trade on Margin
What is margin in trading? Trading on margin is when you borrow money from a brokerage business to make transactions. When trading on margin, investors first deposit cash, which serves as security for the loan, and then pay interest on the margin money they borrow on a regular basis. This loan boosts investors’ purchasing power, allowing them to purchase a bigger number of securities. The securities acquired serve as collateral for the margin loan automatically.
A margin call occurs when a broker who previously issued a margin loan to an investor sends that investor a note requesting that they increase the amount of collateral in their margin account. When a margin call occurs, investors must often deposit additional funds into their account, sometimes by selling other securities. If the investor refuses, the broker has the ability to force the investor to sell his or her positions in order to raise the amounts needed. Margin calls are feared by many investors because they can force them to sell their investments at unfavorable prices.
Margin trading could only be done with cash until last year, and no shares could be used as collateral. The Securities and Exchange Board of India (SEBI) recently eased this requirement by allowing investors to open margin trading positions by pledging shares as collateral.
Margin Trading: Eligibility
To use the margin trading facility, you must have a margin account with the broker (MTF). The margin varies depending on the broker. At the time of opening the MTF account, you must pay a specified amount (minimum). At the end of each trading session, the squaring-off position is required.
Margin Trading: Features
- According to SEBI regulations, only authorised brokers can offer margin trade accounts.
- The Securities and Exchange Board of India (SEBI) and the different stock exchanges define the securities that can be traded on margin.
- Margin-created positions can be carried forward for up to N+T days, where N is the number of days the position can be carried forward for, which varies per broker, and T is the number of trading days.
- Investors who want to use the margin trading facility should open an MTF account with their broker and accept the terms and conditions, stating that they understand the rewards and dangers associated.
Margin Trading: Benefits
- Margin trading is an excellent choice for investors who wish to profit from short-term market movements but do not have enough cash on hand.
- The market regulator SEBI and stock exchanges keep a close eye on the margin trading facility.
- As a security/collateral, securities in the portfolio or demat account can be used.
MTFs increase the purchasing power of investors.
- Magnified Losses: Just as the margin can help investors magnify profits, it can also help investors amplify losses. In fact, you could wind up losing more money than you put in. Investors are unaware that borrowing from brokers is just as binding as borrowing from banks.
- Minimum Balance: You must keep a certain amount of money in your margin trade account at all times. If you can’t keep the minimal balance, you’ll be compelled to sell part or all of your assets to keep the minimum balance.
- Liquidation: If investors fail to comply with the margin trading agreement, brokers have the ability to take action against them. If you don’t fulfil a margin call, your broker has the right to sell your assets to reclaim the margin money.
Margin Trading: Mutual Funds
Because of its transaction mechanism, mutual fund units cannot be purchased through margin trading. Mutual fund units are not sold in the same way that equities are. Mutual fund houses are where investors buy and sell mutual fund units. Only at the end of each working day, when the market closes, are fund prices determined. Margin trading mutual funds is not possible as a result of this restriction.
Tips for Margin Trading
- Investing Wisely: If you wish to invest on margin, you must proceed with extreme caution. It’s fine if everything goes nicely. Margin trading should be used only if you have enough cash to sustain a brief swing against your position while still meeting the margin call.
- Borrow for Short Term: Margin is similar to a loan, and you must pay interest on it.
Margin trading boosts the purchasing power of investors. However, if things don’t go your way, it can result in exaggerated losses. When trading on the margin, you must be exceedingly cautious.
Que.1 How is margin used in trading?
Ans. Trading on margin is when you borrow money from a brokerage business to make transactions. When trading on margin, investors first deposit cash, which serves as security for the loan, and then pay interest on the margin money they borrow on a regular basis.
Que.2 For how long can you trade with margin?
Ans. Investors may typically withdraw cash from a stock transaction three days after selling the shares, but a margin account allows them to borrow funds for three days while waiting for their trades to clear.