What is the Meaning of Credit Balance in a Trading Account?
In the stock market, trading happens based on two accounts: cash and margin. Margin accounts are generally for trading with borrowed funds, and cash accounts are for paying in full amount to purchase a financial asset.
When a trader short-sells an asset, a credit amount gets transferred into his/her account. A short sell is done on borrowed funds; thus, the amount gets credited to the trader’s margin account. A trading account only with a short selling position will show a credit balance.
What is Credit Balance?
When the stock market is in a downtrend, traders can decide to sell a stock at a higher price and buy it back at a lower price. This process is called short selling. Once the trader sells a stock, he/she will get a credit from the broker to buy the sold share later. This is referred to as the credit balance that is transferred to the trading account.
In case of profit, the trader has to pay back the credit amount after subtracting the profit from it. If there is a loss, it gets added to the credit balance and the trader needs to pay it back to the broker.
What Are the Different Aspects of Credit Balance of Trading Account?
Here are some points that you keep in mind regarding trading
- A trading account enables a trader to borrow money from the broker to purchase shares on credit or sell them first on borrowed funds. Let’s say a trader with a cash balance of ₹50,000 wants to purchase shares worth ₹70,000; in this case, a broker can lend the additional ₹20,000 through a credit balance in the trading account.
- The trader has to deposit an extra margin amount to maintain the minimum margin requirement set by the broker.
- Trading with a credit balance involves risk, and the broker may ask for an additional safety margin when losses are not covered. Failing such an obligation, brokers have the right to close the short-sell trading position.
What Are Marginal Stocks?
You can buy or sell marginal stocks on borrowed funds from the broker or short-sell them after paying a safety margin. This works like a loan where stockbrokers ask traders for a collateral security deposit. The broker asks to pledge/mortgage shares of their client before giving them a loan to buy additional shares.
For example, let’s say a trader has shares worth ₹1,00,000 and needs money to buy more shares worth ₹30,000. He goes to the broker’s website, logs in to open portfolio holdings, and selects the shares and the quantity he wants to pledge. The broker will calculate the loan amount after a haircut.
Now, what is a haircut? Haircut is an amount deducted after pledging the shares; this is a risk-measuring procedure that stockbrokers follow while lending margin money. Let’s say the trader pledges shares worth ₹50,000, and the stockbroker agrees to lend ₹38,000 with a haircut of ₹12,000. Now, with this amount, traders can buy additional shares.
The stockbroker will charge interest on the loan amount. Haircut amount varies for different types of shares. A large-cap share has less haircut amount, whereas mid-caps and small caps attract more haircut amount.
Pledged shares get transferred to the broker’s pooled account and are transferable after being unpledged by the trader. A trader can transfer pledge shares from their Demat account to brokers using a PIN or sms based OTP.
How to Handle Credit Margins Carefully?
Credit margin investments are risky schemes with equal odds of profit or loss. Research is needed to make a reasonable investment decision on borrowed funds.
- Debit balance or the payable amount to the broker with interest can fluctuate up and down, leading to increased investment risk. Investing in the right stock at the right time is important to offset the risk.
- A trader should read all the terms and conditions related to the credit balance account agreements, approval of marginal stocks, and their different margin rates.
- A credit balance account runs on a maintenance margin. If this margin is not maintained, the broker has the right to liquidate the shares of the trader. So a trader must deposit funds or collateral into his/her credit balance account if the value of shares drops below the maintenance margin specified in the contract.
- The broker can liquidate the shares purchased on borrowed funds without the consent of the trader if the maintenance margin requirement is not met. Traders should carefully monitor their portfolios to prevent such capital loss.
A credit balance on a trading account has the odds of profit or loss. Investors must carefully research stocks before buying or short-selling them on a credit balance.
A credit balance is like a double-edged sword and should be used carefully while investing. Research carefully before investing and use a stop loss order to protect yourself from huge losses.
Frequently Asked Questions
Is credit balance and margin balance the same?
Credit balance is the amount credited to the margin account only for the purpose of short selling. At the same time, the entire margin balance can be used to buy additional shares. One can collect margin balance as cash or by depositing some shares as collateral
How does credit balance affect trading decisions?
A credit balance has the odds of profit and loss. Before making a trading decision, one must research with due diligence on shares. A strict stop loss order should be placed to prevent capital loss.
What is the most important condition for trading on credit balance?
One of the most important conditions is maintaining the minimum margin requirement. These margin requirements change daily and vary across different shares. Traders must fund their accounts either by depositing cash or pledged shares. Failing to do so may lead to forced selling of shares bought on borrowed funds.
Can I withdraw the margin balance?
No, you cannot withdraw margin balance. However, it can be used to make cash withdrawals against the value of the account in the form of a short-term loan.