Differences between Margin Trading and Short Selling
Stock markets allow day traders to use different methodologies for leveraging the available resources and enhancing returns. Short selling and margin trading are two of the most common trading methodologies that you can use as a funding alternative.
Both these may sound similar in some ways, but they are vastly different in several other aspects. Let’s discuss various differences between margin trading and short selling and how they can help you to maximise your gains.
What Is Margin Trading?
This type of trading methodology allows you to trade with more amount than what you have in your brokerage account. It is necessary to have a margin account with brokerages to carry out margin trading.
Under margin trading, you can take a position in the market by paying only a part of the total transaction value, i.e., the cost of buying the stock or security. This fractional amount that you are paying to undertake trading is the margin money. Margin requirements for various trading segments like stocks, commodities, currencies, futures and options vary.
The Securities and Exchange Board of India (SEBI) decides margin requirements for every trading segment after considering factors like volatility, past performance, current market scenario, etc. However, in every segment, the core foundational aspects remain the same.
How Does Margin Trading Work?
Let’s discuss the working of margin trading with the help of an example:
Suppose you have a brokerage account with a renowned broking house, and there is ₹15,000 in your account. You wish to purchase 300 shares of Company ABC Limited, whose market price is ₹100 per share. The total cost of this transaction would amount to ₹30,000.
In general cases, the brokerage will not allow you to go ahead with this transaction as you do not have the requisite funds in your account. However, it would be possible through a margin account.
As per trading guidelines, margin requirement of this share stands at 20%. Therefore, you would be able to complete the transaction by paying only ₹6,000. But you need to settle the position at the end of the settlement cycle, which is generally two days after trading.
So, after placing a sell order of 300 shares, you need to close the position within T+2 days. However, let’s say that the share price of Company ABC increases to ₹ 130; this means that the total value of your portfolio will rise to ₹39,000.
Note: Recently settlement cycle changed to T+1.
Therefore, you can opt to sell the shares with a profit of ₹3,000. If the share price of Company ABC remains the same or falls, you will have to pay the margin requirement and close your position. Therefore, you will be incurring losses in that case.
What Is Short Selling?
It is a method by which you can sell those shares which you do not have in your Demat account. It is possible by using various margin trading facilities that brokerages offer. You can short sell some shares only after margin trading facility gets activated.
You would not be the owner of the shares; however, you would be eligible to sell them through the margin account and earn profits if the price falls. When the price of the concerned shares or securities falls, you can purchase them with the help of broker and book profits.
This trading methodology comes with a very high risk reward ratio. If it goes in your favour, you will be earning significant profits, but if it goes against your calculations, you could be incurring severe losses as well.
How Does Short Selling Work?
You can understand the working of short selling in these easy steps:
- First, you will be borrowing or loaning corresponding shares from the broker, who will then sell the same on your behalf.
- The brokerage house is liable to credit subsequent proceeds in your trading account on T + 2 day basis.
- After the share price starts to fall, you shall order the broker to repurchase these shares and square off the position.
- Brokerages will use sale proceeds to buy shares and transfer the same into your margin trading facility account.
- The net profit, after taking into account various charges and fees like brokerage charges, taxes, and interest margins, will get credited to your trading account.
Differences between Margin Trading and Short Selling
Here are the various differences between margin trading and short selling:
|Margin Trading||Short Selling|
|It is a trading methodology in which you can indulge in a trade of a higher amount than what is present in your trading account.||This trading position means selling those shares which you do not own and are not present in your Demat account.|
|In margin trading, you will be betting for the price to rise.||In short selling, you would be betting on the price of the concerned security to fall.|
|This is a long position in the stock market.||As the name suggests, it is a short position.|
Short selling and margin trading are two of the most popular trading methodologies among traders. Both aim to increase net returns by efficiently leveraging the resources. However, they come with risks of incurring losses as well; hence, it is imperative that you conduct thorough market research before investing. Hopefully, this article about the differences between margin trading and short selling will help you make better investment decisions.
Frequently Asked Questions
What are the benefits of margin trading?
One of the major benefits of margin trading is that you will not miss out on various trading opportunities due to the lack of funds. Moreover, it serves as a short-term funding mechanism without any additional cost.
What are the benefits of short selling?
Short selling also comes with various benefits, but most importantly, it allows you to speculate and trade in the stocks even if you are not the owner.
Is there any penalty for short-selling?
Individuals who default in providing securities during settlement are liable to pay some penalties, it ranges from 3% to 20%.
Can margin trading put you in debt?
Yes, you may end up with a debt of more value than the actual worth of stock if you leverage the trade by borrowing money from brokerages through the margin account.