What is Margin trading facility allowed by stock brokers?

Margin-trading

It is often said that stock markets are an ocean of trading opportunities. But have you ever lost out on any such opportunity just because you did not have sufficient funds? Well, you are not alone. But there is also a simple solution to this issue and that is the margin trading facility offered by your broker. Are you a new trader and haven’t heard about it? Do not worry we have got you covered. Learn all about the margin trading facility in this blog and start building your trading portfolio at a rapid pace!

What is a margin trading facility?

Margin Trading Facility is similar in nature to a loan arrangement between the broker and the trader. This facility allows the trader to buy or sell securities (such as stocks or commodities) by borrowing money from their broker. This essentially enables traders to control larger positions with a relatively smaller amount of their own capital.

In India, margin trading is regulated by the Securities and Exchange Board of India (SEBI) and involves specific rules and guidelines to ensure transparency and investor protection. Traders have to pledge their securities to the broker as per the initial margin, following which they can get leverage on their trading positions. A key factor to consider is to be aware of the maintenance margin as traders will have to honour the margin call from the broker to cover the potential losses if they breach the maintenance margin level.

What is squaring off the position in margin trading facility?

“Squaring off” in a margin trading facility refers to the act of closing an open position by executing an offsetting trade. This could involve selling shares that were initially bought or buying back shares that were initially sold, effectively ending the trader’s exposure to that particular position.

How does the margin trading facility work?

To avail of the benefit of a margin trading facility, the first step is to inform the broker of the same and open a trading account with a margin trading facility. This is a bit different than having a normal demat account. If a trader is doing normal trading without the MTF and wants to purchase securities worth Rs. 1,00,000, they will have to provide the full capital. On the other hand, the MTF facility allows the trader to provide an initial margin as per the guidelines of the trader.

Let us understand how a margin trading facility works using the following example.

Consider Trader A who wants to purchase shares of Company XYZ worth Rs. 1,00,000.
The trader provides an initial margin of 20% (Rs. 20,000) to the broker as per their guidelines.
The balance amount of Rs. 80,000 will be funded by the broker and against a nominal interest charge which is levied on per day basis.
If the value of shares increases to Rs. 1,20,000, Trader A will have made a profit of Rs. 20,000 in the case of normal trade. However, this profit will be significantly high due to the margin trading facility.
Conversely, if the market takes a downturn, the losses incurred through margin trading would be more significant than those through regular trading. Furthermore, if Trader A doesn’t sell his shares before a specified time, the broker has the authority to sell his shares (known as “squaring-off”) and use the proceeds to cover any potential losses. This is a risk to be aware of when engaging in margin trading.

What is the average margin offered by brokerage firms?

The margin facility offered by brokers varies depending on their individual guidelines, however, the average margin offered by brokerage firms is usually around 20%.

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What is the SEBI rule regarding margin trading facility?

The margin trading facility is regulated by SEBI in India. A few basic conditions levied by SEBI for the MTF are tabled below.

Category	Description
Securities eligible for margin trading	Only the securities in Group 1, which have mean impact cost of less than or equal to 1 and have traded on at least 80% (+/-5%) of the days for the previous eighteen months, are eligible for margin trading facility1.
Eligibility requirements for brokers	Only corporate brokers with a net worth of at least Rs.3.00 crore can offer margin trading facility to their clients
Agreement between broker and client	The broker and the client have to enter into an agreement for providing the margin trading facility, on the lines of the model agreement provided by SEBI
Pledged shares	The shares pledged as collateral will remain in the trader’s Demat account
Margin collection	The margin money is to be collected upfront by the broker for MTF
Intraday profits	The intraday profits accrued through MTF can be used only after the shares are transferred to the demat account.

What is a margin call?

A margin call is a notification from a broker to a trader, typically when the value of the trader’s margin account falls below the required maintenance margin level. It requests the trader to deposit additional funds to cover potential losses or risk having their positions liquidated by the broker to meet the margin requirements.

What are the benefits of margin trading?

Margin trading presents a range of advantages. It empowers traders to leverage their investments, magnifying their market exposure with a fraction of the capital. This translates to the potential for larger gains when market conditions are favorable, creating an exciting prospect for increased profitability. Moreover, margin trading offers the flexibility to swiftly capitalize on short-term trading prospects without waiting for a full settlement, making it particularly enticing for active traders seeking quick opportunities. However, it’s vital to exercise caution, as the promise of amplified profits comes hand-in-hand with the reality of heightened risk. A clear grasp of market dynamics and careful risk management are pivotal before embarking on the margin trading journey.

What are the limitations of the margin trading facility?

The limitations of the margin trading facility include the potential for amplified losses, as leverage can magnify the impact of market downturns. Additionally, traders must consider interest costs, the possibility of margin calls, and the need for a robust risk management strategy to navigate the risks associated with margin trading effectively.

Conclusion

Margin trading is a very common practice for traders and with an increase in the overall number of traders in the country, this facility is now being widely used. While there are multiple advantages of margin trading facilities as discussed above, traders should be aware of the risks as well to efficient trading and securing their trading portfolio.