Margin trading is a service that allows you to purchase stocks that you cannot afford. Here, you may buy shares for a portion of their actual value. This margin is payable in either cash or shares as collateral.
It’s a risky trading method involving depositing money in a brokerage account as security for a loan and paying interest on the funds borrowed. However, stock brokers offer a valuable resource that allows investors to acquire a more significant stake and increase their profits.
You will probably need to open a trading account with a brokerage firm if you are an investor and want to trade on exchanges. You can choose to open a money/cash account or a margin account.
Let us have a deeper look at margin trading meaning and how margin trading works!
Margin Trading Meaning
Margin trading meaning in the stock market refers to the practice of individual investors purchasing more shares than they are capable of affording it. In India, margin trading is also known as intraday trading, and several stock brokers offer this option. You must seek to open a margin account from your broker before you can start trading with one.
Margin trading refers to investors leveraging positions in the market with either cash or securities. The broker funds margin trading transactions. The margin can be determined as soon as you square off your position. When the profit exceeds the margin, you make a profit; otherwise, you lose money.
How is Margin Calculated?
It’s crucial to comprehend how margin interest is determined if you own a margin account and to be able to do it manually if necessary. It’s vital to consider the return on the savings account.
Before calculating, you must first ascertain the margin rate of interest your broker is asking to borrow funds. This query needs to be addressed by the broker. Alternatively, the firm’s website, account confirmation statements, and monthly and quarterly account assertions should be trusted sources for this information.
The interest owed upon loans negotiated between you and the broker about the securities in your account is known as margin interest.
Here is a fantastic example:
If the margin interest rate is 6% annually, let’s say you would like to borrow 60,000 INR to purchase a share you intend to keep for 20 days.
The amount being borrowed must first be multiplied by the interest rate to get the cost of borrowing:
- 60,000 INR x .06 (6%) = 3,600 INR
After that, divide the figure by the total number of days in a year. Instead of the usual 365 days, the brokerage sector often employs 360 days.
- 3,600 INR / 360 = 10 INR
Now finally, multiply the result by the total number of days you have or foresee borrowing the money on margin:
- 10 x 20 = 200 INR
In this case, borrowing 60,000 INR for 20 days will cost you 200 INR in margin interest.
How Does Margin Trading Work?
In India, margin trading is carried out by brokers that provide their clients with margin facilities. The amount you can borrow is known as the margin amount, and it is often expressed as a percentage of the overall trade value.
For example, if you have a margin account with a broker and you want to buy shares worth Rs. 1 lakh, you can borrow up to 50% of the total value of the trade from the broker. This means that you will have to pay Rs. 50,000 from your own account and the broker will lend you Rs. 50,000.
Nevertheless, you need to be aware that there’s a big chance of losing money when you trade on margin. This is due to the fact that you are effectively borrowing money to engage in trading, and if the deal ends poorly for you, you will be obligated to pay the borrowed money along with interest.
Advantages of Margin Trading
- Margin trading is a good option for investors who want to profit from short-term price swings but lack sufficient cash on hand.
- Securities from the portfolios or Demat account may be used as collateral or security.
- MTF increases the rate of return on investment.
- Unlike other forms of loans, Margin accounts do not have specific payback schedules. As long as you fulfill the broker’s maintenance margin criteria, you only have to return the loan when the shares are sold.
- MTF increases the buying power of investors.
- The market authority SEBI and stock exchanges constantly review the margin trade service.
Investments have more purchasing power thanks to margin trading. If circumstances don’t go your way, it might result in amplified losses. When dealing in little amounts, you must exert utmost caution.
Expert investors who are at ease with the dangers should only consider margin trading. Because it’s a high-risk bet that might generate significant losses, it’s not the greatest option for inexperienced investors.
Open a trading account and start the trading game today!