If you want to increase your earnings by taking on some extra risks, you might consider exploring margin trading. Margin trading in India has grown, with traders increasing their potential returns by borrowing money from a broker.
What is Margin Trading
Margin trading refers to the process of trading where an individual increases his/her possible returns on investment by investing more than they can afford to. Here, investors can benefit from the facility of purchasing stocks at a marginal price of their actual value.
Such trading transactions are funded by brokers who lend investors the cash to purchase stocks. The margin can later be settled when investors square off their position in the stock market.
In this respect, margin trading provides investors with access to higher capital for investment, thus helping them to leverage their position in the market, either through security or cash. Subsequently, this trading helps to boost results so that investors can earn higher profits on successful trades.
However, this trading can be quite risky, and investors can earn a profit only when the total profit earned is higher than the margin.
Features of Margin Trading in India
The following are key features of MTF trading in India:
- Investors can amplify positions in securities outside the derivatives segment through margin trading.
- Only authorised brokers that comply with SEBI regulations offer margin trading accounts.
- SEBI and respective stock exchanges pre-define securities eligible for margin trading.
- Investors can establish positions against margin using cash or collateral in the form of shares.
- Margin-created positions can be carried forward for a maximum of N+T days, where N varies among brokers and T represents trading days.
- To access margin trading, investors must open an MTF account with their brokers, acknowledging the associated benefits and risks by accepting the terms and conditions.
SEBI Regulations Regarding Margin Trading
Up until recently, margin trading in India was allowed only through cash, while providing shares as collateral was restricted. However, under fresh regulations put forth by SEBI in 2018, investors can leverage their market position through margin trading by providing shares as security. Further, margin accounts can be offered only by authorised brokers, according to regulations put forth by SEBI.
How Does Margin Trading Work?
When you purchase securities using the funds in your MTF account and their value increases at a rate higher than the interest charged on them, you enjoy greater returns than if you had invested solely with your own funds.
However, on the other hand, the broker charges interest on the funds in MTF accounts for as long as the loan remains outstanding, thereby increasing your cost of purchasing the securities. As a result, if the securities do not appreciate and rather decline in value, you will suffer losses on top of having to pay the broker interest on margin funds.
Example of Margin Trading
Following is a margin trading example that illustrates how the process works –
Mr Agarwal purchases a stock for ₹80 and while squaring off, the price of this stock rises to ₹90. Had he purchased the stock through the cash segment and paid for it in full, Mr Agarwal would have earned a 12.5% return from his investment.
On the other hand, if he purchases this stock through margin trading and pays only ₹30 in the cash segment, he will earn a 75% return on the money he invested.
Margin trading thus makes way for investors to earn a much higher return on investment.
On the other hand, let us consider the value of the stock Mr Agarwal purchased falls from ₹80 to ₹40. If he had purchased this stock entirely through cash, he would have incurred a 50% loss on his investment. However, if he purchases the stock through margin trading, he will incur a loss of more than 100%.
You also have the option of e-margin trading which allows you to buy stock delivery by just paying 25% to 45% of the total amount. This facility allows you to pay the remaining amount at a certain pre-agreed interest rate.
For instance, if you buy 100 shares of Company A and the current price of one share is ₹500, then you would be required to have a total amount of ₹50,000 plus the necessary brokerage amount to proceed. However, in the case of e-margin, you can buy these shares by paying just 25% of the total delivery amount and the remaining 75% margin amount is provided by the broker. This margin amount is then levied with 18% per annum interest.
Thus, from the margin trading calculation illustrated above, it is evident that the process can either bear high profits or substantial losses for investors, depending on how the stocks perform in the market.
Tips and Strategies for Margin Trading
Here are some essential tips you can follow for margin trading:
- Before starting margin trading, grasp your broker's margin requirements and associated risks. Familiarise yourself with rules and regulations and compare MTF interest rates to manage costs effectively.
- Make achievable trading goals aligned with your risk tolerance. Use stop-loss orders to manage risks effectively and prevent impulsive trading decisions.
- Perform in-depth market analysis using technical and fundamental methods to identify potential opportunities. Understand market drivers and conditions before making trades.
- Keep up-to-date with market news and economic indicators that may affect your trades. Continuously educate yourself and maintain discipline in your trading approach.
- Regularly monitor your margin trades and adjust positions accordingly. You must act swiftly in response to market movements and learn from both successes and failures.
- Understand the triggers for margin calls and ensure your margin account value stays above the maintenance margin level.
- Maintain emotional discipline to avoid making impulsive decisions driven by fear or greed. Stick to your trading plan and focus on long-term profitability.
Advantages and Disadvantages of Margin Trading
The following table outlines a brief overview of the advantages and disadvantages of margin trading facility:
Advantages | Disadvantages |
Margin trading gives you access to more capital than you currently possess, allowing for investment in a wider range of securities and potentially increasing profit opportunities. | Margin trading poses significant risks, potentially leading you to lose more than your initial investment. |
Through leveraging, you can multiply your profits when market conditions are favourable, potentially resulting in significant returns, particularly in volatile markets. | When you borrow money for margin trading, you will have to pay interest fees, which can lower your profits, especially if your trades do not bring in the returns you anticipated. |
It enables investment in stocks of high value that may be hard to get with the available cash, providing exposure to prominent companies and potential market leaders. | Brokers can liquidate assets in the MTF to recoup their losses if investors do not fulfil their obligations under the margin trade agreement. |
Margin trading allows you to use securities in your demat accounts or investment portfolios as collateral, providing flexibility in accessing funds for trading purposes. | You are required to maintain a minimum balance in your MTF accounts at all times. Failure to do so may result in additional cash deposits or forced selling of stocks to meet requirements. |
The margin trading facility is subject to supervision by stock exchanges and SEBI, ensuring regulatory compliance and investor protection. | Sometimes, investors may overtrade or become addicted to the high-risk nature of margin trading, resulting in poor financial decisions and significant losses. |
Margin trading in India gives you the opportunity to broaden your investment horizons and boost earnings by leveraging additional capital. However, it comes with significant risks that must be carefully managed. So, before diving into margin trading, it is crucial to have a comprehensive understanding of its features, advantages and risks, as mentioned above.
