Have you been thinking about margin trading in the stock market? Margin is the sum of money that you – as an investor, must deposit with their broker or exchange as a cover for the credit risk that you provide to the broker or exchange. When you borrow cash from a broker to buy financial instruments, borrow financial instruments to sell them short, or enter into a derivative transaction, you will be taking credit risk. Let’s know this a little more in detail.
What is Margin Trading?
Margin trading is a way of buying stocks that you cannot actually afford. You will be permitted to buy stocks for a fraction of their true and current value. This margin is paid in cash or as a security in the form of stock. 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 could possibly be paid later. You make a profit when the profit earned exceeds the margin; otherwise, you lose money.
First things first – how is Margin interest calculated? This is a big question on a lot of minds. You could simply use an equity margin calculator, but you would also want to know how it is done manually. So, here it is!
How is Margin Interest Calculated?
You will find your answer here. Here we have put together the step by step explanation of how to get this done:
Step 1: When you want 30,000 to buy a stock that you intend to hold for a tenure of 10 days where the margin interest is 6% for a year. To calculate the cost of your borrowing, you need to take the amount of money that is being borrowed and multiply it with the rate that is being charged for the borrowing.
That is: 30,000*6% = 1,800
Step 2: Now, take the resulting number and divide it by the number of days in the year – that is, 360 days. Wait! What? Is that what you are wondering? Yes, you are right – there are 365 days in a year.
The brokerage industry would usually use 360 days. So, it would be =
1,800/360 = 5
Step 3: Next, it would be to multiply the number by the total number of days you have borrowed or expect to borrow that amount for. Since it is ten days, it would be:
5*10 = 50.
Step 4 – The Result:
It would cost you 50 in margin trading to borrow 30,000 for a period of 10 days.
While margin can be utilized to boost gains if a stock rises in value and you make a leveraged purchase, it can also amplify losses if the value of your investment falls, which would result in a margin call or the necessity to add more cash to your account to cover those paper losses.
Heads up: Just remember that whether you profit or lose on a trade, you will still owe the same margin interest as the original transaction.
Know your risks before you can know your rewards. Given here are some of the risks that margin trading does carry. Only, and only if you have the appetite for it, should you move forward. If you know you can handle these risks- there could be nothing stopping you.
What are the Risks that are Involved in Margin Trading?
Here are some major risks that this type of trading involves, and you might want to know them clearly before starting off:
- If the margin can help investors increase their earnings, it can also increase their losses. In fact, you could wind up losing more money than you put in. Investors do believe that borrowing from brokers is much simpler than borrowing from other banks or institutions and that dealing with a broker is easier than dealing with a bank. However, they are unaware that borrowing from brokers is just as binding as borrowing from banks.
- At all times – you will have to maintain a minimum amount in your margin trade account. If the balance does fall below the required minimum, your broker will request that you maintain an adequate level. If you can’t keep the minimum balance, you’ll be compelled to sell part or all of your assets to keep the minimum balance.
- If investors fail to comply with the margin trading agreement, brokers have the authority to take legal action against them. If you don’t fulfill a margin call, your broker has the right to sell your assets to reclaim the money.
But, apart from the big part that you would still owe if you lost, there are some pretty good benefits to margin trading. Want to know them? Just keep reading.
What are the Pros of Margin Trading?
There are some great deals when you do begin to margin trade, and they are mentioned here:
- Margin trading is a great choice for the investor that wants to gain from the big price swings in the short term – but does not have enough cash in hand to do so.
- As security/collateral – securities in the portfolio or Demat account can be used.
- MTF will increase the rate of return on investment capital.
- They would also increase the buying power of the investor.
- The margin trade facility is frequently monitored by the market regulator SEBI and stock exchanges.
Growing in the stock market also involves a matter of risk. But, when you have the right expertise to handle the risks that come your way – you can be confident. Margin trading, too, is one such growth opportunity.