Margin trading is essentially a way to maximize your purchasing power by borrowing the amount of money from the stockbroker. In simple, terms it is borrowing money from the broker to buy stocks of the company. Here you use your own capital and the rest amount is funded by the broker. It is normally used for the intraday trading and not for the purpose of delivery based buying or trading. For example, you have Rs. 10,000 in your account and if you go with the margin trading, then you can borrow an additional Rs. 10,000 or 15,000 to buy the shares.
It can be said without any doubt that the margin trading is one of the excellent solutions, especially for the intraday traders or investors who have a shortage of funds but want to make money. If you decide to do this kind of trading, then the stockbroker may provide leverage or intraday margin of 4 to 10 times than the money or shares you actually hold in the trading account. It is to be noted that the margin amount you may get depends upon broker to broker. Furthermore, the traders are not allowed to buy penny stocks or Initial Public Offerings (IPOs) on the margin trading as the risk in these kinds of shares is quite high.
Rules of Margin Trading
The process of margin trading is quite simple. All you are required to do is open a margin account. For this purpose, you have to place a request to the broker for the same. If you request for the margin account is approved, then you have to pay a certain amount in cash up front to the broker, which is also known as the initial margin amount. After the payment of the initial margin amount, the broker will give 4-6 times of margin to trade. From the margin amount, the trader can recover some of the amount in case the trader suffers losses or fails to repay the borrowed amount. There are some prominent rules or features that must be kept into consideration in case of margin trading. These are as follows:
- A minimum margin amount is also required to be maintained throughout the session. This is because the stock market is extremely volatile and the share prices can fall or decrease drastically beyond expectations. The initial margin amount has been prescribed 50% and the maintenance margin has been prescribed as 40% by the SEBI.
- You must square off the position at the end of every trading session. If you have purchased the shares, then you are required to sell them. Similarly, if you have short sold the shares, then you will be required to purchase them at the session end.
- If you want to take the delivery of the shares, then you will be required to pay an extra or additional amount to the broker.
If you fail to follow these steps, then the stockbroker may square off your positions automatically or without any notice.
Margin Trading Example
Suppose, you are interested in buying shares of the Company ABC worth Rs 2,00,000, then the margin amount that you may have to pay will be around 75,000. It is to be noted that the margin amount required to be paid may differ from broker to broker. The remaining amount of Rs 1, 25,000 will be funded by the broker. In case, you want to take the delivery, then all you are required to do is to repay the funded amount. The interest will be levied on the funded amount.
Normally, with the amount of Rs 75,000, you may purchase only Rs 75,000 worth of shares. Using the margin trading facility, you have the option to buy shares worth Rs 2, 00,000 with the Rs 75,000 limit. It is important to note that short selling is not allowed in the margin trading facility.
SEBI Norms on Margin Trading
There are certain margin trading norms or guidelines that have been prescribed by the Securities and Exchange Board of India (SEBI), which are as follows:
- Only the corporate brokers with the net worth of at least Rs 3 crore are allowed by the SEBI to offer the margin trading facility to the traders. It has been mandated by the SEBI that the brokers will have to provide half-yearly certificated certified from the auditor to the exchanges that confirms their net worth.
- For lending the amount to the traders, the brokers have two options i.e. they can use their own money or borrow from the banks or Non-Banking Financial Companies (NBFCs) which are regulated by the Reserve Bank of India (RBI). Besides this, a broker is prohibited to borrow from any other source.
- The brokers are not allowed to use the money of any trader for lending to another client. Furthermore, the brokers have to provide some essential details to the stock exchange like the name of the client, PAN number, type of holding (promoter or non-promoter) and type of the shares (collateral or funded). If the brokers have borrowed the money to provide the margin trading facility to the clients, then they have o provide the name of the lender and the amount of money borrowed.
- The stock exchanges will have to come up with the ‘Rights and Obligations’ documents, both for the brokers and clients. It is compulsory for the brokers and traders to go through the document and sign it.
- The brokers will have to provide the list of the situations under which the securities of the traders may be squared off or liquidated. The situations will be mentioned in the Rights and obligations document. Moreover, the brokers have to main separate ledgers for every client.
- If there is any dispute between the trader and broker with regard to the margin trading facility, then it will be treated as the normal trade dispute and will be sorted out under the investor grievance redressal mechanism and arbitration mechanism of the stock exchange.
It is important that you must keep a tab on your risk-return before you carry out margin trading facility. It is also essential that you must not get overboard because at the end you are borrowing the money from the broker and you have to repay him with the interest. Try to borrow the money after ascertaining your financial capability and goals.