Understanding the Concept of Margin Money in Trading
Margin Money: Investors don’t want to let go of investment opportunities, as they can help earn high returns. Taking market positions can be challenging when there is a lack of funds. Luckily, investors can avail of the margin trading facility and borrow funds from stockbrokers. Before you open a margin account with your stockbroker, it is essential to understand the concept of margin money. Let us delve deeper and understand its use for both the investor and the broker.
What is Margin Money?
Now, let us understand what margin money is. When investors do not have ample funds but want to take larger market positions, they can borrow funds from their stockbrokers. This facility of borrowing funds from the stockbroker is called margin trading. Not all stockbrokers in India offer the margin trading facility to retail investors. Also, you might be required to open a margin trading account to borrow funds from your stockbroker.
When a broker lends funds to the investor, it demands collateral. The collateral can be cash deposited in your margin account or securities. When the broker asks you to set aside a sum of money or certain securities as collateral for margin trading, it is called margin money. For instance, you might be asked to set aside Rs 10,000 to purchase shares worth Rs 1 lakh (10% margin requirement).
Uses of Margin Money
Margin money is essential in many ways for both the investor and the broker. It is deposited when you are borrowing funds from the broker to purchase stocks, options, or futures. It is also used when investors try to take long or short positions with intraday trading. The broker can minimise the risk of default by asking the investor to set aside a sum of money. As an investor, you will have a substantial amount (expressed as a percentage of the total margin) for emergencies. For instance, you can use this money to pay the broker when expected returns are not achieved.
Margin and Margin Trading
Now that you understand the meaning of margin money, let us delve deeper. Investors need to understand the basic difference between margin and margin money. Margin is the concept of buying securities with the help of borrowed funds from the broker. As discussed above, you need a specialised margin account to take loans from the broker. Margin trading is the practice of making investments and generating returns through borrowed money. The investor repays the broker in a given tenure with the help of generated returns.
It all starts with the initial margin, which the broker decides. It is the initial amount of money deposited with the broker for sanction of the entire margin amount. Let us say you want to purchase stocks worth Rs 20,000. Your broker sets the initial margin at 50%. It means you must deposit Rs 10,000 initially with the broker to get the entire Rs 20,000 as a margin.
The initial margin is not the only money you must deposit with the broker. Investors must also consider the maintenance margin before indulging in margin trading. The maintenance margin is the minimum amount of cash you must keep in your account until you fully repay the broker. The maintenance margin is usually lower than the initial margin, around 10% to 20%. The maintenance margin acts as collateral for the broker in the case of margin trading. When investors miss their instalments, brokers can use the maintenance margin for repayment.
Investors must also be familiar with the concept of margin calls . The broker sends you a margin call when you fail to keep the maintenance margin amount in your account. A margin call reminds you to deposit more money in your margin trading account. A margin call can be addressed by depositing the required amount in your account. When you ignore margin calls repeatedly, the broker might sell your securities to cover costs. Beginners in the stock market must understand these consequences before they indulge in margin trading.
Since margin trading is a form of borrowing, it has associated costs. When investors repay funds in short tenures, they pay less interest. On the other hand, a lengthier tenure for repayment might add up to interest costs. Consider the initial margin, maintenance margin, interest rate, and other factors before applying for the margin trading facility.
Advantages and Disadvantages of Margin Borrowing
When investors do not have ample funds to purchase assets, they rely on margin borrowing. They can always repay the broker with the returns earned on the asset. Margin trading allows investors to take larger positions even with a small amount. It is beneficial for retail investors who do not have access to a large trading capital. Despite its advantages, there are a few risks associated with margin trading. The biggest risk with margin trading is the risk of default. When you face losses in your investments, you might not have the required money to repay the broker. You might miss margin calls and end up losing your collateral. Learn more about advantages and disadvantages of margin trading in the stock market.
Example of Margin
The requirements for margin trading might change from one broker to another. Let us say your broker requires a 40% initial margin for offering funds. Consider that you want to purchase stocks worth Rs 40,000. In such a case, you must deposit Rs 16,000 with the broker as the initial margin. Considering the margin requirement is 10%, you must always keep a minimum of Rs 4,000 in your margin trading account. It is crucial to note that the initial margin is required only for borrowing funds from the broker. Once you get funds, you must focus on meeting the maintenance margin requirements. You will get a margin call when you fail to keep a minimum of Rs 4,000 in your account.
Investors using the margin trading facility must be familiar with the concept of margin money. It is the minimum amount of cash or securities you must keep aside as collateral for margin trading. The margin money amount will change from one broker to another in India. Before borrowing funds, you must consult the broker regarding the initial and maintenance margin requirements. Check out the margin trading facility now!