Margin trading is a way of buying stocks you can't afford. You are permitted to purchase stocks for a fraction of their true value. This margin is paid in cash or in stock as collateral.
Margin trading is defined as investors leveraging positions in the market with cash or security. Your margin trading operations are funded by your broker. When you square off your position - the margin can be paid later. You make a profit when the profit earned exceeds the margin; otherwise, you lose money.
Margin Funding meaning - A short-term loan facility that investors can utilize to make up for any shortfalls they may have while trading futures and options or purchasing equities at a pre-determined interest rate. On subsequent trades, this fixed interest is paid to the brokerage for short-term loan transactions.
An investor with a Demat account has two options for obtaining this service: they can contact their brokerage firm's investment advisor or go online and apply for it through their agency's website.
Here are the major attributes of margin trading:
1) All of the investors who are looking forward to a margin trading facility need to provide an undertaking by initiating their acceptance of all the terms and conditions applicable to the MTF. The margin trading facility is not a separate trading account, but it is offered in the same existing trading account and linked Demat account.
2) Traders who get the MTF facility could provide their margin amount either in cash or in equity collateral.
3) The MTF facility lets the investor create a leveraged position in securities as a multiple of what they could afford according to cash on hand. This especially - is relevant in the non-derivative segment where future leveraging is not possible.
4) There is no standard limit to the number of days the position could be carried forward, and that is at the discretion of the broker and also customized according to the relationship that the broker and the client enjoy. Generally, clients that give a higher brokerage and have a long-standing relationship do get special privileges. Normally, this would extend for 2-3 months in most cases.
5) Brokers can't offer margin trading facilities on all the stocks listed on the stock exchange. The master list is defined by SEBI, which is the outer limit of offering the MTF facility to clients. However, most brokers also impose their own level of checks and balances and even prune the list further in the interest of safety and security.
6) SEBI rules only allow corporate brokers registered with SEBI to offer the margin trading facility. Individual brokers and brokerages structured as partnerships can't offer this facility.
Read here: What is SEBI
A margin funding account means a brokerage account that the broker would lend to the client to buy stocks or other financial products. The loan in that account is collateralized by securities that have been purchased, and it also comes with an interest rate that has already been decided. As the customer is investing with borrowed money - he or she is using leverage that would magnify gains and losses for the customer.
When an investor buys securities with margin funds, and the securities appreciate in value beyond the interest that has been charged on the funds, the investor would earn a better total return than if they only bought securities with their own money. This is the benefit of using margin funds.
The brokerage firm will charge interest on the margin fund for as long as the loan is known to be outstanding - which will, in turn, increase the investor's cost of buying the securities. When the securities decrease in value, the investor would be underwater and would have to pay a sum of interest to the broker on top of that.
If a margin account's equity goes below the maintenance margin level, the brokerage firm will make a margin call to that investor.
In a specified number of days, most often - three days, the investor needs to deposit more cash or sell some of the stock to offset all or a portion of the difference with the security's price and the maintenance margin.
The brokerage firm will have the right to ask a customer to increase the amount of capital that they have in a margin account, sell the investor's securities if the broker feels the funds are at risk, or also sue the investor when they do not fulfil a margin call or when they have a negative balance in the account.
The investor will have the potential to lose more money than the funds deposited in the account.
For this, a margin account would be suitable only for sophisticated investors who have a thorough understanding of the additional investment risks and needs of trading with a margin.
A margin account would not be used to buy stocks on margin in an individual retirement account, a trust, or other fiduciary accounts.
You will have to have a margin account with the broker to get a margin funding facility. The margin will vary from broker to broker.
You will have to pay a certain sum during the opening of your margin trading account.
You will also be required to maintain a minimum balance at all times. If you fail to maintain the minimum balance, then your trade will be squared off. The squaring-off position is mandatory at the end of every trade session.
Mentioned here are some of the advantages of margin trading:
It is a short-term borrowing facility that investors can use to cover any shortfalls they may encounter when purchasing stocks or trading futures and options at an agreed rate of interest. The brokerage charges the investor interest for borrowing money to buy stocks or trade.
Generally, the regular equity delivery charge would apply to MTF. Interest cost is an added cost to the extent of debits on the trading account.
Penalties are inclusive of additional charges, penal interest, and also blocking of the margin account if the minimum margin is not paid.
Margin trading offers greater profit potential than traditional trading but also greater risks.
The margin could also be utilized to borrow money against the account's worth in the form of a short-term loan.