Margin trade is an advanced online day trading strategy that allows you to take large positions in the stock market. Putting it differently, margin trades allow you to purchase more stocks than you can otherwise afford. Besides, it involves purchasing and selling securities in the same trading session. However, nowadays most online brokers have relaxed the stock holding duration. Moreover, the rise of virtual exchanges has made margin trades accessible to both big and small traders.
Since margin trade is an active short-term trading strategy, you can make quick bucks from the same. However, you need to be aware of a few things before undertaking a margin trade. We will throw light on the same in the successive paragraphs.
All you need to know about margin trades
1. Selecting an online broker
As per SEBI guidelines, online trading in India requires you to open Demat and trading accounts. For executing margin trades, you are required to open an additional account – the margin account. Your prospective broker must be authorized as per SEBI regulations to provide an MTF (Margin Trade Financing) facility. Plus, you also need to check the margin rates and the overall brokerage costs while evaluating a potential broker. The lower the margin rates and brokerage costs, the higher will be your potential gains.
2. Understanding margin trades
While opening a margin account, you have to deposit an upfront amount, known as initial margin (IM), in your account. The initial margin is a specified percentage of the total stock purchase value and is pre-determined by your broker. This initial margin can be paid in cash or kind – that is in the form of securities. In other words, you pledge your securities to borrow funds from your broker to finance stock market purchases.
On the day of margin trade execution, you may ensure a minimum margin (MM) amount in your account. The minimum margin is necessary for tackling rapid market fluctuations. Suppose, a stock priced at Rs 1000 decreases by 5.5%. The IM and MM are fixed at 9% and 5% respectively. In this case, your total trade-off equals 4.5% (9% – 5.5%), which is lesser than MM. In that case, you have to pay 0.5% to your broker to replenish the MM.
Moreover, you need to square off your position by the end of every trading session. In other words, if you have gone long, you need to sell. Conversely, if you have gone short, you need to buy.
Lastly, you may convert every margin trade into a delivery trade. Thus, you need to have ready cash to pay the stock purchase price, brokerage charges, and all other applicable fees.
If you fail to do any of the above, your broker will automatically square off your open positions.
1. Margin trade risks
Margin trades magnify both gains and losses. In other words, you may lose much more than you invested. Repaying borrowed funds to the broker is as binding as repaying traditional bank loans. Hence, you may tread with caution.
You must also ensure that your account always has the stipulated minimum balance. Any shortfall therein has to be replenished on time. Failure to do so will lead to the sale of your collateral securities by the broker to maintain the required minimum balance. Besides, your broker can also liquidate your pledged securities if you breach the margin trade agreement or do not respond to your broker’s margin calls on time.
Final words
Margin trades are profitable for seasoned investors who wish to take advantage of stock price volatilities with less cash in hand. It not only enhances your buying power but also gives you a much higher rate of return than regular investment strategies.
You may go through SEBI’s pre-defined list of securities that are eligible for leveraged trades. Derivatives do not qualify for leveraged trading in India. Moreover, as per the recently adopted peak margin policy, SEBI has currently increased upfront margin requirements from 50% to 75%. This new system has been implemented to curb large-scale speculative trading practices.
