Who is eligible to trade on a margin?
Stockbrokers with the margin trading facility typically offer it to all traders and investors who apply for it. There are generally no eligibility criteria that you need to satisfy to be able to trade with margin money.
However, the amount of leverage you are eligible for may vary depending on the stockbroker and the security you wish to purchase.
What are the types of margins?
Margin is often categorised into three types. Let us explore the different types of margins in detail.
Initial margin
The initial margin is the minimum amount you must deposit to open a futures position. It’s a fixed percentage of the total contract value and applies whether you take a long or short position. In options trading, this margin is typically required only for initiating long positions.
Maintenance margin
The maintenance margin is the minimum balance you need to maintain in your trading account to keep your futures position active. This ensures the broker can cover any losses if the trade moves against you. Falling below this level can trigger a margin call.
Margin call
A margin call is a warning from your broker when your account balance drops below the maintenance margin. To avoid your position being squared off or penalised, you must add funds promptly to restore the rRs. equired margin.
Variation margin
When your account balance falls short of the maintenance margin, the amount you need to add is called the variation margin.
For example, if the required maintenance margin is Rs. 10,000 but your account has only Rs. 5,000, the variation margin is Rs. 5,000—this is the shortfall you need to cover.
Working of Margin Money
When traders ask, "What is margin money?", the answer lies in the concept of leverage. Margin money is the amount an investor must deposit to open a leveraged trade. Leverage allows you to control larger positions than your account balance would normally permit—offering the potential for higher profits but also increasing the risk of losses, as borrowed funds are involved.
Here’s a simple example:
Suppose you have Rs. 10,000 in your trading account and wish to enter a futures contract worth Rs. 50,000. If the broker requires a 10% margin, you’ll need to deposit Rs. 5,000. This amount acts as collateral and is used to cover potential losses on the trade.
- If the trade moves in your favour, you can close the position and pocket the profits.
- If the trade goes against you, the margin is used to offset the losses.
- If your losses exceed the margin available, the broker may close your position, or you may be required to add more funds to maintain the trade.
Advantages and disadvantages of Margin borrowing
Advantages
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Disadvantages
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Leverage can earn greater gains
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Leverage can result in greater losses
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Increased flexibility
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Account fees and high-interest charges
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More flexibility than other loans
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Risk of margin calls and forced liquidation
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Potential for self-fulfilling cycle
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Potential for significant losses
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Example of Margin money
Margin trading allows you to leverage your investment by borrowing money from your broker. For example, if you deposit Rs 10,000 in your margin account and your broker offers a 2:1 margin, you can potentially buy up to Rs 30,000 worth of securities. However, you'll only own Rs 10,000 worth of shares, and the remaining Rs 20,000 is borrowed from the broker.
It's important to note that the buying power in your margin account fluctuates based on the market value of the securities you hold. As the value of your securities changes, so does your buying power.
Remember, margin trading can amplify both profits and losses. It's crucial to understand the risks involved and use margin wisely.
Understanding margin and margin trading
Margin refers to the down payment an investor provides to a broker or lender when borrowing funds to buy securities. This amount is deposited into a margin account, which is separate from a regular brokerage account. A margin account is specifically used for margin trading, where the broker lends money to the investor for purchasing securities.
Buying on margin
Buying on margin means purchasing securities using borrowed funds from a brokerage. After the investor contributes the initial margin amount, the broker lends the remaining value needed to complete the purchase. This allows the investor to buy more securities than they could with their available capital alone. A margin account is necessary for this type of trading and differs from a standard cash account, which is used for regular trades without borrowed funds.
Minimum margin requirement
To open a margin account, the broker must obtain the investor's formal consent. This may be part of the general account opening process or a separate agreement with specific terms. The minimum margin, also known as the maintenance margin, is the minimum equity an investor must maintain in the margin account after buying securities. Falling below this level can trigger a margin call, requiring the investor to deposit more funds or sell securities to restore the balance.
Conclusion
With margin money, you can enter into large positions by depositing a relatively small amount of capital. While this could potentially increase your profits, it also increases the level of risk. Therefore, you must first ensure that you thoroughly understand all of the risks involved before using margin money to trade.
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