Margin Trading 101: An Introductory Guide for Beginners

Margin trading is a provision provided to investors to help them invest in stocks at a fraction of their actual value and earn high returns. A margin of the stock’s market value is paid by the investor and the rest is loaned by the stockbroker to the trader. 

The stockbroker charges an interest on this loaned amount from the trader. With this method, investors can leverage their position in the market either through the securities they already own or cash. Here we will look at everything a new trader needs to know about this provision to make informed decisions and produce higher returns.

The Working

Here is a look at how margin trading works.

1. To get started, investors first need to open a margin trading facility (MTF) account. 
2. You can open your MTF account with your current stockbroker
3. The MTF account is not the same as a Demat Account. 
4. The MTF account lets the broker disburse funds into it for investors to carry out margin trades
5. The securities that one can invest in, under margin trading, are predefined by SEBI 
6. With an MTF account, investors can expand their buying power, which could lead to potentially higher gains. 
7. An interest rate is charged on the amount that a broker loans the investor
   

Here’s an example to help you understand the workings of margin trading better:

• An investor, let’s call them X, has ₹20,000 but wants to invest in shares worth ₹50,000. 
• With Margin Trading, they can purchase the share by paying only a percentage of the total amount. 
• If a broker has a 20% margin requirement, X will need to pay only 20% of ₹50,000, i.e. ₹10,000  
• The remaining 80%, i.e. ₹40,000 is lent to the investor by the broker. 
• The broker then charges a nominal interest on this ₹40,000 lent by them.

The Features

To understand the provision of margin trading better, it is important to be aware of some of its main features. Here’s a list:

1. Under margin trading, investors can easily leverage their market position against the margin requirement in two ways; (a) either by using cash or (b) using the securities they already own as collateral.
2. All the securities that are available to be invested in under margin trading are pre-defined by the Securities and Exchange Board of India or SEBI together with the stock exchanges.
3. As and when the market performs well, the margin under the collateral stock also grows which can then be used to buy more securities under MTF.
4. Under margin trading, investors can carry forward their positions up to T+ N days. 
5. Here T = The trading day, and N = the number of days the position can be carried forward.  

The Benefits

Margin trading comes with its fair share of benefits. Some of them are listed below:

1. Margin trading makes for a great method to invest through for investors wanting to increase their market position but not having enough capital to invest to do so. 
2. Purchasing extensive stocks on margin can potentially lead to an increase in an investor’s leverage in the Indian stock market leading to potential benefits from even small market fluctuations.
3. When the market is on the rise, margin stocks perform better than most other commonly traded shares which can help maximize the returns on your investment.
4. Even if an investor does not have cash up-front to leverage, they can use the securities in their Demat Account as their collateral.

The Risks

Similar to any other investment provision, margin trading also comes with its fair share of risks. Some of them are listed below.

1. Seeing as margin trading can enhance gains when the market moves upwards, it also ends up leading to larger losses if the market moves unfavourably
2. Though interest costs are usually nominal with reputed brokers, if they are not managed well, they will start into the returns gained from the trades. 
3. In cases when the collateral value falls under a specific level, the investor will get a margin call from the broker to ask the investor to add the necessary funds
4. When a margin call is not heeded, the margin amount is not maintained in the account or to cover losses, brokers can suddenly liquidate an investor’s position should the need arise, leading to potential losses for the investor. 

In Conclusion

Margin trading, when done right, can prove to be a great way to invest and gain potentially higher returns. However, both the benefits and risks associated with it need to be acknowledged and looked into before beginning one’s margin trading journey.