Skip to main content

Stock Market: Margin trading - A high-risk trading

Margin trading increases your buying power, but it enlarges your risk as well. When to give in to the temptation of this high-risk trading strategy, and when to avoid
Double gain; Double pain. This is how the concept of margin trading can best be described. As the name suggests, margin trading enables you to trade with borrowed funds/ securities or, in other words, by paying only a part of the total investment amount. It is, in fact, a leveraging mechanism which enables you to take exposure in the stock market over and above what is possible with your own resources.

However, while margin trading increases your buying power, it enlarges your risk as well. In a way, amplifying your gains and losses to the same degree. That is why it is still not a recommended way of trading, although the lure of big money has always drawn investors into the lap of margin trading. So much so that an increasing number of small investors are now giving in to the temptation of this high-risk trading strategy which had traditionally attracted only short-term punters and deep pocketed investors.

To understand the mechanism of margin trading more clearly, let’s take the case of a person who buys 600 shares of XYZ Co at Rs 400, using the margin finance facility. Assuming his broker offers him 50% leverage on the transaction, person effectively pays only half the total transaction amount (Rs 120,000 out of Rs 240,000) at the time of purchase. The balance is borrowed from the broker/ bank. Now, if the share price rises to, say, Rs 450 after a few days, Mehra would be richer by Rs 30,000 (minus the interest that he would have to pay to the broker/ bank for the borrowed money) and the bank/ broker would gain to the extent of the interest amount on the funds borrowed. However, if the share price drops to Rs 360, person would be incurring a loss of Rs 40 per share, exposing his financier to more risk if the share price were to plummet further.

It is typically during such times that the broker is forced to make margin calls to clients, asking them to either deposit more money into their account or sell some of the securities in their account to meet the margin shortfall.

Now if that person fails to make good the margin shortfall, his stock broker would sell his shares for the stipulated amount in consideration. Thus, apart from losing his investment, person would also stand to lose the opportunity to make any profit in the future, were the share prices to recover.

However, if you look at the same transaction without the margin trading facility, you will realise that though it trims the profits, it effectively reduces the risk when the share price slides. If person had not used the margin trading facility while buying shares, he would not have liquidated his holdings when the market corrected. It is another matter that unlike the previous transaction, he would have been able to buy only 300 shares.

Thus, given that margin trading can lead to inflated profits and losses, experts advise that it should be opted only by traders with a high-risk appetite. Risk-averse or general investors should better keep off from it.

Anyway, you are not allowed to dabble in margin trading on your own as market regulator Sebi, from time to time, has been prescribing eligibility conditions and procedural details for allowing this facility. Thus, for availing of this facility, you need to register, as prescribed by Sebi.
You need to fill in the prescribed documents such as Margin Trading Letter, Margin Trading Agreement and New Finance Letter, apart from account opening and DP Form.

Also, only corporate brokers with a net worth of at least Rs 3 crore are currently eligible for providing the margin trading facility to their clients. Before providing this facility, however, the member and the client have been mandated to sign an agreement for this purpose in the format specified by SEBI. The agreement provides the terms of margin trading, the extent of margin and other details.

The initial margin has been prescribed as 50% and the maintenance margin as 40%. Also, the ‘total exposure’ of the broker towards the margin trading facility should not exceed the borrowed funds and 50% of his ‘net worth’. While providing the margin trading facility, the broker has to ensure that the exposure to a single client does not exceed 10% of the ‘total exposure’ of the broker.

For providing this facility, a broker may use his own funds or borrow from scheduled commercial banks or NBFCs regulated by the RBI. However, the broker has not been allowed to borrow funds from any other source

It has also been specified that the client shall not avail the facility from more than one broker at a time. Another significant point to note is that the facility of margin trading is available for Group 1 securities and those which are offered in IPOs. The list of scrips which are covered by this facility for NSE and BSE are limited (about 600). Any scrip which is not included in the said list shall not be funded.

Thus, given the complexities of margin trading, you should invest only if you have an above average understanding of the market. Otherwise your losses would be more than your gains.

Systematic Trading Systems used with a lot of discipline is also one smart way to make money using margin trading facilities. The important aspect of this system is that human emotion is not involved in this and all buying and selling triggers are generated by a software which is based on a scientific analysis of historical market trends. Whatever be the case, experts advise investors to put only that much money which they can afford to lose. This is just to ensure that one’s life-long earnings are not wiped out through this process!

WATCH OUT

· Margin trading amplifies your gains and losses to the same degree
· It should be opted only by traders with a highrisk appetite and who have surplus cash to back them up during a stock market meltdown
· Invest only if you are a savvy investor and have the stomach for calculated risks
· Do it for short-term bets only
· Put only that much money which you can afford to lose
· Trading software can also help you take prudent decisions based on technicals, not emotions

Popular posts from this blog

ICICI Pru Mutual Fund Dividend

ICICI Prudential Mutual Fund has announced dividend under the following schemes: Scheme Dividend ( Rs /unit) ICICI Pru Capital Protection Oriented Ser V Plan B-D 0.03611325 ICICI Pru Capital Protection Oriented Ser V Plan B Direct-D 0.03611325 ICICI Pru Balanced Advantage Direct-DM 0.06 The record date has been fixed as February 08, 2017. ------------------------------ ------ Invest Rs 1,50,000 and Save Tax upto Rs 46,350 under Section 80C. Get Great Returns by Investing in Best Performing ELSS Funds Top 4 Tax Saver Mutual Funds for 2017 - 2018 Best 4 ELSS Mutual Funds to invest in India for 2017 1. DSP BlackRock Tax Saver Fund 2. Invesco India Tax Plan 3. Tata India Tax Savings Fund 4. BNP Paribas Long Term Equity Fund Invest in Best Performing 2017 Tax Saver Mutual Funds Online Invest Best Tax Saver Mutual Funds Online Download Top Tax Saver Mutual Funds  Application Forms For further information contact  SaveTaxGetRich on 94 8300 8300 ------------------------------ ------ Leave y...

What is Financial Freedom?

Invest In Tax Saving Mutual Funds Online Download Tax Saving Mutual Fund Application Forms Buy Gold Mutual Funds Call 0 94 8300 8300 (India)     There were many things common between our Freedom fighters. All had the Single vision (Free India), common goal (independence) and had a disciplined and focused approach. They were ready to do anything and everything and had made so many sacrifices to see India free . But the road to freedom was not easy .They had faced lot many hardships, went to jail so many times and even confronted physical and mental torture from the British. There was one more thing which proved to be an advantage to our fighters that most of them were professional lawyers. The knowledge of legal issues and its impact on our country at large has helped them counter various bills and proposed new laws by the then government. It is due to their continuous effort that we are able to achieve the goal of Independent Indi...

Hidden Bank Fees

  What Banks Hide From Customers Imagine after a peaceful and exciting holiday you receive your bank statement with steep charges. You then rush to your bank and start confronting staff members and to your dismay, you come to know that the high end debit card was charged very heavily. Wouldn't this cause damage to your finances? So remember, the world outside is full of deceptive and double cheating people. Unethical practices are always used by company sales person in order to meet the target. Credit card companies, mutual funds and bank institutions always play dirty tricks to lure customers and the practices are rampant. So here's how you should be careful while dealing with your banks: High End Debit Card Charges While opening an account with a bank you opt for a debit card with minimal charges. But later on when you upgrade your card and opt for high end debit card the annual charge rise by a good amount. Though such a card has slew of features but it all comes at a high ...

Partial withdrawal from PPF

  Public Provident Fund (PPF) account has a lock in period   If you opened a PPF account to meet your retirement needs,, think twice about withdrawing from this fund before retirement. But provided it's an emergency here are the rules. Public Provident Fund (PPF) account has a lock in period before which you cannot withdraw your money.   The partial withdrawal is allowed after the completion of 6 financial years . This means that you will be allowed a partial withdrawal from 1 April 2017. The maximum partial withdrawal allowed is the least of the following: 50 percent of the account balance at the end of fourth financial year, 31 March 15 50 percent of the account balance of the end of previous financial year, 31 March 17.   There's a loan option available on your PPF account between the fourth and the sixth financial year. You can obtain a loan of up to 25 per cent of the balance in your account. However, this will attract interest of 2 percent more than the prevailing ...

Updating a minor PAN card upon becoming adults

  Updating a minor's PAN card once they become adults A PAN card issued in the name of a minor does not contain the minor's photograph or signature, and therefore, cannot be used as a valid proof of identity. Once a minor PAN card holder turns 18, the relevant changes must be made in the PAN records. A new card is then issued bearing a photograph and signature. Application The applicant is required to fill up the "Request for new PAN card andor changes or correction in PAN data" form. The form can be filled up online by accessing NSDL's Tax Information Network website and clicking on the online PAN application tab. Information The applicant must mention the existing PAN number in the application and check the `photo mismatch' and `signature mismatch' boxes, and submit the online form. The form must also be printed out, signed by the applicant, and submitted along with two photographs. Documents Identity and address proof in the form of a copy of the app...
Related Posts Plugin for WordPress, Blogger...
Invest in Tax Saving Mutual Funds Download Any Applications
Transact Mutual Funds Online Invest Online
Buy Gold Mutual Funds Invest Now