The new margin system is one of the significant steps to strengthen the risk management system in the markets, resulting in it being more efficient in the long term. The increasing limit of upfront margin has already impacted the intraday trading volumes. The Securities and Exchange Board of India (SEBI) is ready to further raise the upfront margin limit to 75% from June to August. From 1st March 2021, it has hiked from 25% to 50% to curb speculative trading.
What is Margin Trading?
Margin trading refers to the leveraged positions of day traders as they purchase securities by paying a marginal amount only from the trade’s actual value. Their brokerage firms invest the remaining amount.
Suppose you bought Rs.2,00,000 worth of equities using Rs.1,00,000 borrowed and Rs.1,00,000 in cash with the expectation of a rise in its price. Your analysis goes correct, and the value of these equities increases by 25% to Rs.50,000. The amount you borrowed from your broker stays at Rs.1,00,000, and your equity becomes Rs.2,50,000. You can settle the borrowed amount with your profit.
Margin Trading Facility allows you to buy more stocks with your insufficient money for such value of stocks as your brokerage firm can fund your trading transaction. You can pay the upfront margin amount in cash or shares and settle the borrowed amount later.
MTF seems like a good facility for day traders, but it is a double-edged sword.
Suppose, in the above example, the market opposes your analysis and the stock price goes down by 20%. The amount payable to the stockbroker is Rs.1,00,000, plus the interest on this amount. Besides, bearing a loss of Rs. 40,000, it will be a huge amount to pay.
In case you could not pay the borrowed amount to your brokerage, it will issue a margin call and ask you to pay the dew amount. If you do not pay even after the margin call, it can liquidate your assets to recover borrowed funds. It may force you to square off your trading positions. No matter how much loss you have to bear on forced liquidation. Therefore, make sure you maintain the minimum margin in the margin account at all times without any fail to avoid forceful liquidation. Read every term stated in the agreement before signing it.
Strategies to use Margin Trading
Margin trading prudently can be proved a valuable tool if a trader uses it correctly. Here are the strategies for safe margin trading:
Make confident trades only.
It would be best to make a margin trade for securities you are confident about that its price will move in your anticipated direction. You have to be very selective about a stock to trade. Keep in mind that wrong analysis and anticipation can cost much more than you invest.
Take small positions.
If you believe that margin trading can benefit you with a large trade, you need to reconsider this belief. Professionals suggest starting small at first instead of exposing a lot of money in taking a position as the trial is best for beginners. It will help you to understand the risks of margin investing.
Avoid margin calls.
When brokers choose a margin call, you are indeed close to an unfavorable position. Try to make a minimum margin in your margin account as soon as possible to avoid margin calls. Otherwise, you may lock losses as your broker can liquidate your positions even without your consent.
Thus, this way cautious use of margin trading can benefit you.
Margin trading supports a trader when he/she has a shortage of funds for making a trade. However, you should note that it can magnify your profits and losses as well. Therefore, one should trade on margin only and only with the higher success rate of the trade. Then, it is a good idea. Otherwise, it is a gamble on an unsure perception.
If you want to experience the marginal trading facility, you can go with a small trade first and understand how it works.
You can utilize the securities in your demat account as collateral against marginal trading. However, make sure you do not reach a margin call. It may lead to forceful squaring off your trade positions irrespective of market conditions and no matter how much loss you will have to bear.