What is Margin Trading? A Detailed Guide
Margin trading, a stock market feature, allows investors to purchase more stocks than they can afford. Investors can earn high returns by buying stocks at the marginal price instead of their market price. Your stockbroker will lend you money to buy the stocks, and like any other loan, will charge an interest rate. As an investor, you will have access to larger amounts than the existing funds you possess. Thus, you can leverage your position in the market via securities or cash that allows more significant exposure to the market. Margin trading, sometimes also referred to as leverage trading, has its own set of risks, but it will yield higher returns if you can speculate the market movement correctly.
How does margin trading work?
- Investors wishing to trade through margin trading must hold a margin trading facility (MTF) account. You can request your broker to open an MTF account. This is different from a Demat Account. The broker disburses funds in the account for you to trade marginally. SEBI pre-defines the securities that are allowed under an MTF account periodically. An MTF account enhances your buying power resulting in higher gains. Brokers will charge an interest rate on the loan amount, i.e., the money you put in for margin trading.
- For instance, a person X owns Rs 20,000 but wants to purchase shares worth Rs 50,000. He can buy those shares through Margin Trading by simply paying a percentage of the total amount. If an authorised broker sets 20% as the margin requirement, you will pay 20% of Rs 50,000, and the balance amount will be lent to you by the broker. 20% of Rs 50,000 is Rs 10,000, and the broker will lend you the remaining Rs 40,000 and charge interest on the margin amount.
- Now, if X owned Rs 50,000, he could easily buy the Rs 50,000 worth shares. Assume that the share price rises on the same day, and now his invested amount increases to Rs 55,000. In this case, his return on investment would be 10%. In the case of market trading, however, where his investment amount was only Rs 10,000, the returns he would get would be significantly higher than 10%.
- Conversely, if the market falls, X would incur hefty losses through margin trading than he would have through regular trading. Additionally, suppose X does not sell his shares before the specified time. In that case, the broker has the right to sell shares, usually referred to as squaring-off, and liquidate the assets to mend any potential losses.
What are the features of margin trading in India?
- Investors can leverage their position in the stock market against the margin requirement by providing cash or securities as collateral.
- Securities traded through an MTF account are pre-defined by SEBI and the stock exchange.
- Only SEBI authorised brokers are allowed to open an MTF account for investors.
- When market conditions appreciate, the margin from your collateral stock will also increase, thus helping you buy more securities under MTF.
- You can carry forward your positions up to T+ N days, where T is the trading day, and N is the number of days that position can be carried forward. N is determined by individual brokers and will vary for different brokers.
What are the benefits of margin trading?
- Investors who want to increase their position in the market but hold inadequate investment capital can use margin trading. It is an ideal facility to make high profits in a short period.
- When you buy more extensive stocks with a small amount, it amplifies your leverage in the Indian stock market. With increased leverage trading, you can benefit from small market fluctuations.
- When the market is performing well, the margin-traded shares will reap higher returns than the commonly traded shares. That way, you can maximise the returns on your investment.
- Some form of collateral is required for the broker to lend you funds in MTF, for which you can put up your existing shares in your Demat Account as your collateral.
What are some of the margin trade practices to remember?
- Margin trading requires you to be always cautious. If you get high returns, you also can incur high losses. You should not falter at the risks of margin trading and be able to meet margin calls.
- Avoid borrowing the maximum amount from your MTF account. Once you develop an optimistic approach towards the stock market, you can confidently trade marginally.
- The margin amount is the loan that the broker provides; therefore, the loan amount is subject to a compounding interest rate.
Read more about margin calls here.
What should you know about SEBI regulations?
Before, authorised brokers were allowed to accept only cash as collateral against the amount lent to the investors. However, as per the Security and Exchange Board of India (SEBI) guidelines, you can now provide shares as collateral.
Additionally, SEBI has also introduced the ‘Margin Pledge.’ The Margin Pledge is where brokers report any margin exchange between the broker and the investor four times a day. Brokers also follow other stringent norms so that SEBI can achieve the utmost transparency in Margin Trading. Several banks such as HDFC Bank allow you the initiative to this pledge request. Learn more about it here.
SEBI has also iterated that those opening fresh Demat accounts and trading accounts will be given the facility of nomination or even opting out of the nomination. SEBI has also introduced a new framework to include a change in or updation of PAN, signature, contact and bank details; the issue of duplicate securities certificate, consolidation of securities certificate, etc.
Margin trading can significantly increase your buying power, but it can also result in amplified losses if the market turns its back on you. Thus, you must be extremely caution when investing through margin trade.
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*Terms and conditions apply. This is an information communication from HDFC bank and should not be considered as a suggestion for investment. Investments in securities market are subject to market risks, read all the related documents carefully before investing.