Q1. What is more important - margin or exposure?

Notional exposure is the total value of a trader's position. It is not equal to the margin paid to get the position. For example, let's say that the current price of Nifty is 26000. And we purchased 1 future with a lot size of 65. The margin that we have paid is ₹2 Lakhs. However, the notional exposure is 26000 x 65 = ₹16,90,000

There is a significant difference between the margin paid and the exposure gained, leading to high risk and high reward.

Why Margin Creates a False Sense of Position Size

Many traders are attracted to instruments with low margins. They get a thrill when trading with high leverage. So first, let us understand leverage.

As per the previous example, the total exposure is ₹16.9 Lakhs. Whereas the margin required to initiate the position is ₹2 Lakhs. So the leverage is 16.9/2 = 8.45x.

This means that for every 1% move, the profit/loss moves by 8.45 %

So in our example, if Nifty goes up from 26000 to 26130 (0.5%), the total profit can be calculated as follows:

But 1 lot @ 26000

Sell 1 lot @ 26130

So net profit is 130 points. Once we multiply this by 65, the total profit is ₹8,450

Note, the total profit per cent onthe margin deployed is 8450/200000 = 4.225%

As can be seen from the example, Nifty moved by just 0.5%; however, the profit on the margin deployed was far greater at 4.225%

The ratio of 4.225/0.5 = 8.45, which is equal to the leverage that was calculated earlier.

While the above example shows the positive aspect, the losses are magnified as well

If instead of going up, Nifty went down by 0.5% to 26000-130 = 25870. The total loss in this case would be ₹8,450, which is 4.225% of the margin deployed.

Why Position Sizing Should Be Based on Exposure, Not Margin

Position sizing should always be based on exposure rather than the margin paid. Moreover, margin requirements keep changing based on the volatility of the instrument, regulatory frameworks such as SPAN, and different broker policies. Also, the margin requirements may increase based on market conditions.

On the other hand, the exposure is constant and reflects the actual economic value at risk. Therefore, a trader should ask:

“How much notional exposure do I control relative to my capital?”

Not:

“How much margin do I have left?”

The Hidden Danger: Exposure-Based Risk vs Capital

Position sizing is very important for the long term survival. When position sizes are too large relative to capital, it can lead to huge moves in the account. A small market move against the trader can wipe out a large percentage of capital. The drawdowns can be very large, and the rollovers can become very risky. Often, the broker issues a margin call if the margin is not fully met. So, position sizing should be optimal to ensure long-term survival. A good trader has position size under control, which helps him withstand volatility and reduce emotional stress.

Position Sizing for Option Sellers

Options are super-leveraged products, and again, position sizing plays a very important role. Both option buyers and option writers are affected by position sizing. Let's take an example.

Let's assume that Nifty is at 26000 and an option writer has sold 26000 CE for ₹200. The lot size is 65. And the total margin is around ₹1,25,000. This is where the trader must calculate his notional exposure. The notional exposure in this case is 26,000 × 65 = ₹16,90,000

Though the margin is ₹1.25L, the exposure is almost 13.5 times.

So this creates a significant risk for the trader again. If the market moves upwards violently, the losses can be amplified 13 times. A 2-3% upmove in Nifty can wipe out a trader.

So Nifty goes up 4% and closes at 27000 at expiry, the 26000 CE is ITM and will be traded at around ₹1,000. The trader's total loss will be ₹800.

In absolute terms, the total amount lost is ₹800 × 65 = ₹52,000. If the trader had used ₹1.25 Lakh as margin to take the position, the loss would be approximately 40% of the capital.

To be successful, a trader should follow these thumb rules.

Define maximum notional exposure per unit of capital. Usually, a 3x leverage is more than sufficient.
If you are a conservative trader, if 1-2x is sufficient
If you are ultra aggressive, 4-5x is good.
But many beginners end up with a leverage of 10x, which can be very risky.

Conclusion

Traders should know the difference between the margin paid and the exposure gained in the position that they are trading. The notional exposure is the true measure of risk, and leverage is the amplifier. To be a successful trader, good position sizing is a must. The trader should focus on exposure to avoid forced liquidations in the event of adverse moves. It also helps control drawdowns and provides emotional stability. In trading, staying alive is the primary edge.
Position sizing based on exposure is how traders stay in the game.

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