What is Margin Buy and Sell in the Stock Market?
If you are even slightly familiar with the markets, you must have definitely heard of the term margin. It is a complicated aspect of the market and an essential part of intraday trading. Traders make use of margins to take larger positions in the market. It helps them get more leverage thus increasing their chance of higher profits and risk of higher losses.
For a better understanding of margin buying and selling, read this blog till the end.
What is Margin?
Before delving deeper into margin buying and selling, it is essential to first understand what margin is. These are basic yet intricate aspects that can make a huge difference in your performance in the market.
Margin, in market terms, is collateral that a trader keeps with their broker in exchange for the risk the brokerage house takes on the trade. It is used both for buying and selling purposes when it comes to trading. In other words, it is a token amount that a trader must pay to his broker to execute margin trading.
What is Margin Buying?
We all know that your purchasing power in the stock market is reflected by the total amount of money you have in your demat account. But what if we told you that you can buy multiple times beyond your purchasing power in the market?
When you execute a trade by putting some token money and borrowing the rest from your broker, it is called buying on margin. The token money is your margin which is also used as collateral unless you return the borrowed funds back to your broker.
Example of Margin Buying
To understand this better, let us take an example. Let’s say Tarun wishes to buy 100 shares of Company X. It is currently trading at ₹200 per share. Now in order to buy 100 shares, Tarun needs ₹2 lakh available with him.
He now has two options. He can either add ₹2 lakh to his demat account and buy the desired quantity. Another option here is that he can put in the token money that is required to execute the trade and borrow the rest from his broker. Now if he takes the second choice, the token money that he will put in for this trade shall be the margin amount. This entire process is called buying on margin.
What is Margin Selling?
If you are now thinking that margin selling is just selling the shares you bought on margin, then please stop right there. Because it is a different concept.
Margin selling happens when a short seller sells shares that he does not own. In this process, a seller takes a stand that the price of a certain share will fall in the future. Since he does not already own those shares, he borrows them first. Later on, when the price of the share falls down to his target price, he buys them and returns them to the original lender.
As per SEBI Regulations, a trader needs to have a 20% margin to sell short. This is to ensure that if the price of the share rises after the sale, the seller compulsorily delivers the shares and doesn’t change their mind.
How Margin Selling Works? – An Example
Suppose Varun wants to short sell 100 shares of company V at ₹1000 each. As a general rule, he must own the shares to be able to sell them. But with margin selling, he can borrow the 100 shares and sell them if he thinks that the price of these shares will fall in the future. The total value of selling these shares comes down to ₹10 lakh. However, he will have to put a margin of ₹2 lakh in order to borrow the shares.
Advantages of Using Margin in Trading
If you ask a professional trader, he can list down numerous advantages of trading with a margin for you. It is after all that many of them employ to make money. For starters, here are some of the advantages of margin trading that we have compiled for you.
- Helps leverage a bigger position: This is the biggest and foremost advantage of trading with a margin. In margin trading, a trader can leverage a bigger position that they could not have with their own money. Thus, it helps them in increasing their purchasing power.
- Higher chances of profit: Being able to buy or sell in larger quantities increases the chance of making higher profits. If you see the above examples, it is evident that if the traders had used just their money, their profits would have been limited in proportion to their funds only.
- Flexibility: As you might have already understood, margin trading is investing using debt. However, if you look at other loan terms, you would realise it is much more flexible. You do not need to undergo the rigorous application process nor follow any stipulated repayment schedule like conventional loans.
- Allows better use of existing conditions in the market: It may so happen that you see a share price falling and you wish to make money out of it. But you can sell those shares on margin if you do not own them. This is called taking advantage of a situation. Margin trading has allowed traders to make the best use of their circumstances.
Disadvantages of Using Margin in Trading
We can’t stress enough on how complicated the process of margin trading is. As fancy as it sounds, it comes with its own disadvantages. Here are a few of them:
- Not suitable for laymen: Because of the complexities involved, margin trading is not a beginner-friendly concept. It requires a thorough understanding of the market and experience or you can end up losing a lot of your money.
- Increased chances of loss: A chance to earn higher profits also increases the risk for higher losses. If a margin trade goes south, the trader loses double the money than he would have otherwise had he used only his funds. Thus having a big appetite for risk is very important.
- Maintenance margin in margin calls: Maintenance margin is the minimum amount a trader must maintain in his account after a trade is executed. If your maintenance margin goes down, you might receive a notification from your broker to bring the balance at par with the margin requirement.
- Your broker can take action on your behalf: Since you are operating on borrowed money, your broker also gets a say in your trades. That is why if you fail to meet the margin calls, your broker can square off your position without your consent or notifying you.
All said and done, the bottom line of margin trading is that if you bet your money on the right horse, you can win big. If you root for the wrong side, you can also lose big. That is why even the most experienced traders use margin trading with caution and back it with thorough research. If you are starting a new, consider studying it first before jumping right into the trade.
Frequently Asked Questions
Is it smart to buy and sell using margins?
Buying and selling using margins is a good strategy to leverage a bigger position in the market. However, it is smart to use it only if you understand the concept in depth. If you are not well versed in it and doing it just in hopes of earning big, you can end up losing all your money.
Since it is borrowed money, do I need to pay interest on margin trading?
Margin trading is just like taking a debt to make your investments. And wherever there is a debt involved, an interest fee comes attached to it. Therefore, if you trade on margin, you will have to pay interest on the borrowed funds.
Why would I want to trade using margins?
Traders mainly use margin trading to take advantage of the prevailing market conditions. In the situation where a trader does not have enough funds or securities that he can use to make more profits, he can resort to margin trading.
How many types of margins are there in the Indian market?
Essentially, there are 5 types of margins implemented in the Indian stock market. In the cash market segment, the different types of margins are Value at Risk Margin, Extreme loss margin and Mark to Market Margin. In the futures and options segment, there is an Initial margin and an Exposure margin.