Introduction

In the margin in share market refers to the borrowing of funds from a broker to trade financial assets, and stocks, beyond the capital available in your account. It allows investors to leverage their position, increasing potential profits by buying more shares than they could with their own money. 

However, trading on margin also involves higher risk, as losses can be amplified just as much as gains. Margin trading is common in intraday trading and can be a powerful tool when used wisely, but it requires careful management to avoid substantial financial losses.

When diving into the world of trading, one term you’ll likely encounter is “margin.” So, what is margin trading in the share market and why does it matter? Let’s break it down in this guide.

Margin and Margin Trading

In the share market, “margin” refers to the amount of money an investor borrows from a broker to purchase securities, using their existing securities or cash as collateral. This allows investors to leverage their positions and buy more shares than they could with just their own funds. Essentially, “Margin” is the difference between the total value of the investment and the loan amount provided by the broker.

Margin trading, on the other hand, is the act of buying stocks by borrowing money from the broker, making it a high-risk, high-reward strategy. Traders are required to maintain a certain minimum balance, known as the margin requirement, in their margin accounts. If the value of the securities falls below this level, brokers issue a margin call, demanding the investor to either deposit more funds or sell some of the assets to cover the loss. 

Margin trading amplifies potential returns, but also increases risks, as losses can exceed the initial investment. Therefore, traders must monitor their positions closely and use strategies like stop-loss orders to minimize risks.

Types of Margin in Share Market

1. Initial Margin  

The initial margin is the minimum amount an investor must deposit with the broker before initiating a margin trade. It is a percentage of the total transaction value, which ensures that the trader has some skin in the game. For example, if the initial margin requirement is 20%, and an investor wants to buy ₹1,00,000 worth of shares, they must deposit ₹20,000 upfront, with the broker lending the remaining ₹80,000.

2. Maintenance Margin  

The maintenance margin is the minimum balance an investor must maintain in their margin account after the purchase has been made. If the value of the securities in the margin account falls below the maintenance margin level, the broker issues a margin call. This requires the investor to either add more funds or sell a portion of their holdings to meet the required level. For example, if the maintenance margin is 25%, and the account value falls below that threshold due to market decline, the trader must replenish the account or face liquidation of their holdings.

3. Variation Margin  

The variation margin is a dynamic margin requirement that changes based on market movements and the daily fluctuations in the value of the securities held. It is typically seen in futures and options trading, where daily mark-to-market adjustments are made. Brokers require additional funds if the value of the investor’s position drops below a certain level during volatile market periods.

4. Cross Margin  

Cross margin refers to the practice of using the total value of multiple positions in an account to meet margin requirements. It allows an investor to offset losses in one position with gains in another. This type of margin is beneficial for traders who maintain multiple trades, as it reduces the risk of margin calls and liquidation by spreading risk across different holdings.

5. Ad-hoc Margin  

Ad-hoc margin is an additional margin requirement that brokers can impose on certain stocks or during specific market conditions. It is often applied to high-volatility stocks or in times of heightened market uncertainty. This margin is temporary and typically comes into play when the broker assesses a higher risk in particular securities.

6. Delivery Margin

This margin is imposed to ensure that both parties in a contract fulfill their delivery obligations. In the case of stock futures or commodities, if an investor opts for physical delivery at the contract’s expiry, the broker requires a delivery margin. This margin ensures that the buyer has sufficient funds to take delivery, and the seller has the ability to deliver the actual asset. Delivery margins are generally higher than regular initial or maintenance margins, as they cover the risk involved in the actual transfer of assets.

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Margin Trading: How Does it Work? 

Several ways define how Margin trading works for traders in India. Here’s a detailed breakdown of how margin trading works:

1. Opening a Margin Account

To engage in margin trading, an investor must open a margin account with a broker. This is different from a regular cash account, as it allows the trader to borrow funds. Brokers typically require an initial deposit, known as the initial margin, to begin trading on margin. The initial margin is usually a percentage of the total purchase amount.

Example: 

If the initial margin requirement is 50% and the investor wants to buy ₹2,00,000 worth of shares, they must deposit ₹1,00,000, and the broker will lend the remaining ₹1,00,000.

2. Leveraging Buying Power

With margin trading, the investor can buy more shares than they could with their own funds alone, effectively leveraging their position. The broker finances the remaining portion of the purchase price, making it possible for traders to control larger investments than their capital allows.

Example:  

If an investor has ₹50,000 in their account and the broker offers a 50% margin requirement, the investor can buy ₹1,00,000 worth of shares, borrowing ₹50,000 from the broker.

3. Interest on the Loan

When an investor borrows money to trade on margin, the broker charges interest on the loaned amount. The interest is accrued daily, and the rate varies by broker and market conditions. This interest must be paid whether the trade results in profit or loss. The longer the investor holds the position, the more interest they will accumulate.

4. Maintenance Margin

Once the trade is executed, the investor must maintain a minimum amount of equity in their margin account, known as the maintenance margin. This ensures that the investor has enough funds to cover potential losses. If the value of the securities in the account drops below the maintenance margin, the broker issues a margin call.

Example: 

If the maintenance margin is 25%, and the value of the purchased shares falls from ₹1,00,000 to ₹80,000, the investor must ensure that at least ₹20,000 (25% of ₹80,000) is still in the account.

5. Margin Call

A margin call occurs when the equity in the investor’s margin account falls below the maintenance margin level due to market declines. When this happens, the broker demands that the investor deposit additional funds or sell a portion of their assets to bring the account back to the required level. Failure to meet the margin call may result in the broker liquidating the investor’s securities to cover the shortfall.

Example:  

If the maintenance margin requirement is 25%, and the investor’s account falls below that, the broker may issue a margin call. The investor can either deposit more money into the account or sell some of their holdings to raise the necessary funds.

6. Potential for Higher Returns

One of the main reasons investors use margin trading is the potential for higher returns. By borrowing funds, investors can increase their exposure to the market and benefit more from favorable price movements. For example, if an investor buys shares on margin and the stock price rises, they can sell the shares at a higher price and pay back the broker while keeping the profit.

Example:  

If an investor buys ₹1,00,000 worth of shares on a 50% margin (₹50,000 their own, ₹50,000 borrowed) and the stock price increases by 10%, they can sell the shares for ₹1,10,000. After repaying the broker ₹50,000, the investor keeps the remaining ₹60,000. The return on their initial ₹50,000 is 20%, double the return they would have earned without margin in share market trading.

7. Increased Risk

While margin trading can lead to larger profits, it also magnifies losses. If the price of the purchased securities falls, the investor will still owe the broker the loaned amount, plus interest, regardless of the loss incurred. In extreme cases, the investor may even owe more than their initial investment.

Example:  

If an investor buys ₹1,00,000 worth of shares on a 50% margin, and the stock price falls by 20%, the shares are now worth ₹80,000. The investor still owes the broker ₹50,000, but their remaining equity is only ₹30,000. The loss on their initial ₹50,000 investment is 40%.

8. Short Selling with Margin

Margin trading is also used in short selling, where an investor borrows shares and sells them, hoping the price will fall so they can buy them back at a lower price and return them to the lender. Short selling also carries substantial risk, as potential losses are theoretically unlimited if the stock price rises.

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Risks Involved in Margin Trading

1. Amplified Losses  

One of the biggest risks in margin trading is that it amplifies not only profits but also losses. If the stock price moves against the trader’s position, the losses are magnified because the investor is trading with borrowed money. This means that an investor could lose more than their initial investment. For example, if an investor buys ₹1,00,000 worth of shares on a 50% margin and the stock loses 20% of its value, the investor’s loss will be 40% on their actual capital.

2. Margin Calls  

When the value of the investor’s account falls below the broker’s maintenance margin requirement it is termed a Margin call. If the investor does not meet the margin call by either depositing more funds or selling some securities, the broker has the right to liquidate the investor’s holdings. This forced liquidation can happen at a disadvantageous time, locking in losses that the investor may have otherwise avoided if given more time.

3. Interest Costs  

Since margin trading involves borrowing funds, the investor is charged interest on the loan. These interest costs can accumulate quickly, especially if the position is held for a long time or if the interest rate rises. Even if the trade is successful, the interest on the borrowed funds will reduce overall returns. If the stock does not appreciate enough to cover the interest expense, the investor can end up with a loss despite the stock price remaining flat or even rising slightly.

4. Market Volatility  

Margin in share market increases the exposure to market volatility. Sudden and unexpected price swings can lead to significant losses in a short period. Highly volatile markets are especially risky for margin traders, as rapid changes in stock prices can quickly trigger margin calls or force the liquidation of positions. Additionally, during periods of high volatility, brokers may raise margin requirements, leading to an increased risk of margin calls and a need for more funds.

5. Liquidity Risk  

In times of market stress or low trading volumes, liquidity can dry up, meaning there may not be enough buyers or sellers at favourable prices. If a trader needs to sell securities to meet a margin call, they may struggle to do so without selling at a lower price than anticipated, which can exacerbate losses of margin trading. Liquidity risk is especially high with less liquid assets like small-cap stocks, where price spreads can widen dramatically during market downturns.

In Short! 

Margin in share market is an essential part of the trading journey. The more you trade, the more pros and cons you will explore about margins. Margin trading can enhance your investment potential, but it also comes with risks that you need to be aware of. Always do your homework, choose the right broker, and monitor your investments closely to avoid losses. 

As a trader, how likely is it to never lose money in the stock market? Well, the answer is that no matter how experienced you are, losses are a part of the trading journey. It can’t be true that a trader only earns profits and never faces any loss. But, with proven methods and strategies losses can be reduced. 

So, would you trade with our advanced trading platform, Jainam? 

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