Margin Trading is the facility by which an investor can draw a loan from a broker to invest in financial securities. Investors must have a margin account to leverage the benefits of margin trading.
Unlike a cash account that allows spending only the money deposited, a margin account enhances an investor’s spending ability with debt. In addition, margin loans do not have an implicit repayment schedule, unlike the traditional banking system. However, traders are required to maintain a certain threshold.
Margin Interest Rates
Margin interest is the interest rate on the margin trade. The margin interest rates are usually lower than unsecured personal loans and credit cards.
When an investor makes losses, and the margin amount falls below a certain level, the broker asks the investor to deposit more money into the margin account. During such cases, the investor must divest a part of their assets or add more funds to meet the margin requirement.
A margin account facilitates investors to gain access to more leverage to fund their purchases, increasing their chance to reap more profits. In addition, investors can also use the margin account for day trading. The Securities and Exchange Board of India (SEBI) has permitted investors to trade on the stock exchanges by utilizing margins in their Demat accounts.
What is a Demat account?
A Demat A/C, short for a dematerialized account, is the repository where investors can hold financial securities in digital form.
How Is Margin Calculated?
Margin is the amount of money lent by brokers as leverage. The margin limit is the amount of cash an investor is eligible to borrow. The margin limit is calculated as a percentage of the total value of securities in an investor’s portfolio.
For instance, if an investor has Rs. 1 Lakh worth of securities, and the broker allows for a 50% margin limit; the investor would be eligible for Rs 50,000 to purchase additional securities.
Advantages of Margin Trading
Here is a brief overview of how margin trading can benefit investors:
(i) Better Investments
Increased leverage helps an investor make more significant investments, enhancing their portfolio.
(ii) Short-term profits
Margin trading benefits investors looking for profit-making through shorter-term market price fluctuations but facing a cash shortage.
(iii) Portfolio Diversification
Margin Trading helps investors enhance the diversification of their portfolios.
Gaining access to increased capital gives the investors a chance for broader portfolio diversification. Therefore, margin trading benefits investors to align themselves better with their goals.
Risks Involved In Margin Trading
While margin trading has numerous benefits for investors, it also possesses certain risks.
(i) Magnified Losses
Margin trading can help yield profits for investors. However, on the flip side, investors can lose all of their invested capital due to unfavorable market movements or underperforming securities.
(ii) Minimum Balance
Investors are required to maintain a minimum balance in their margin trade accounts. As a result, a portion of the capital remains locked in. If the investor incurs losses gets a margin call to refill the minimum balance.
By the terms of the margin loan agreement, if an investor fails to comply with a margin call, the broker has the right to take action. For instance, if an investor is not fulfilling the margin call requirements, the broker has the right to divest any remaining assets from his margin account.
Keys For Successful Margin Trading
- The invested amount should not exceed the sum of money that an investor can afford to lose.
- Investors should borrow less than the allowed limit. Investing small amounts into the market at first can help boost confidence for larger trades.
- Investors must borrow the margin loan for shorter intervals to avoid unnecessary interest expenses.