Having a stock trading strategy and sufficient capital are the most important things you need to make money in the stock market.
With enough capital and no strategy, you would be left with no capital at all very soon.
In that case, you need to move onto another section and learn how to make a strategy first.
That would help you save your hard earned money from the wrath of stock market.
But what if you have a very good trading plan or strategy but you do not have enough cash to trade?
Should you leave the opportunity to pass on? Or you would trade with that little available cash and be satisfied with meagre profit?
Keep on reading further and find out how you can make that little cash work for you ; How you can keep your savings account swelling trade after trade.
We are talking about margin trading. You may have heard about it earlier. You may be knowing about buying on margin or short selling of stocks. You may know that it is a risky game.
But do you know how you can use margin trading wisely in your favour? How buying stocks on margin can be more rewarding than cash buying?.
We will find out here what is margin trading? What does buying a stock on margin mean?
Table of Contents
What is Margin Trading
Margin trading is one of the stock trading tools. It makes an important part of trading strategy for the professional traders.
What is margin? Margin means borrowed money.
By definition, this is the technique of stock trading with borrowed money.
It allows a trader to trade with much higher number of stocks than the usual number of stocks allowed with cash trading.
Margin Trading provides you cash leverage to buy stocks for trading. This cash leverage is provided by the stock brokers in the form of a loan to buy stocks.
So it becomes very useful when you have limited cash with you but you want to trade big.
Opportunities for trading or trading signals keep arising in the different stocks at different times in the stock markets.
With margin trading, you can multiply your profits substantially with the limited available cash.
With good knowledge of margin trading, you can make your savings bank account grow up significantly.
However, Cash leverage can be a double edged sword. If not used wisely, it can be equally destructive for your savings account.
For margin trading, the trader is required to pay some defined percentage amount of the total trade value. This is called as the Initial Margin.
The initial margin depends upon if we keep trade for intraday or carry forward it as a positional trade.
It varies from around 5% to 30% of the total trade value for intraday or positional trade respectively. It also varies with broker to broker.
There is certain amount which you need to maintain with the broker to keep your trade open. This is called as the Minimum Margin.
You have to maintain minimum margin to keep your trade going on or open. Not being able to maintain the margin requirements may lead to closure or squaring off your trade by the broker.
This happens when the trade starts moving in the opposite direction of your expectation. In this case the minimum margin starts increasing.
If the stock price stay around there or starts rising, then there is no increase in minimum margin.
Types of Margin Trading
You can use margin for stock trading for intraday trading or positional trading.
In intraday trading, the trading position created is closed or squared off before the end of the same trading session.
In a positional trade, the trading position is carried forward to next trading sessions.
I use ICICIDirect Trading Account. They provide two options for margin trading depending upon the time horizon of the trade taken :-
Broker Mode Margin Trading
With broker mode margin trading, you can trade for intraday only.
In intraday trading with margin, you can get margin or loan by paying only 5% as the initial margin. So margin means, you can get cash leverage of nearly 20 times of your capital.
In intraday trading, the profits are earned with small moves in stock prices. The trading position is closed quickly to avoid losses due to high volatility in stock prices. With margin trading, these small profits get multiplied to big profits.
Advantage with broker mode margin trading is that it allows you trade the stocks both ways; for upside or downside.
That means, you can buy a stock first in expectation of price rise and close at higher price with profits.
If you expect a fall in a stock price, you can first sell the stocks and later on buy back at lower price with difference in prices being your profit. This is called Short Selling.
With broker mode trading, the trading position needs to be closed before the session of trading for that day ends. If not done by the client or the trader, the trading position is closed automatically. This is done by the broker or the system 15 minutes before the market closes.
Client Mode Margin Trading
Client mode margin trading is ideal for positional trades. Here, you expect your price targets to be met in next few days or weeks or months.
The client herself/himself can decide when to exit the trade. However, the position can not be kept for unlimited time. There is a time limitation.
In case of BSE, you can hold your position for 180 days. NSE allows it for 6 days only.
The catch here is that you will have to pay the interest charges for the amount you borrowed from the stock exchange and time period you hold your position. It is around 0.5% per month for both the exchanges.
Client mode margin trading allows you only buying on margin. It does not allow short selling as with broker mode.
On the second day of holding, these stocks are seen as Pending for Delivery in your trading accounts.
The above image shows a trading position in client mode which is now Pending for Delivery.
It is for Dabur (DABIND) stock, 1000 stocks showing Initial Margin, Minimum Margin, Available Margin and other particulars of the trade.
You can keep them as Pending for Delivery if you are purely a trader. You can also convert these stocks to delivery if you have changed your mind later on to stay invested in that stocks.
You would need to pay the pending amount if you want to convert it to delivery. The stocks will be shifted to your demat account.
Another thing to keep in mind is the brokerage charges. In case of client mode trading, you are charged with the same rates as with cash buying.
Brokerage rates are much higher for cash trading as compared to margin trading. Whereas for margin trading, the usual brokerage rates are around 0.05%, for cash trading they are around 0.5%.
Brokerages are different for different brokers.
Margin Trading vs Cash Trading
With cash trading or cash buying, you can buy the stocks only up to value of your cash holding.
Suppose you have ₹ 1,00,000 capital in your savings account. You want to buy a stock XYZ which is trading at a market price of ₹ 400 per share.
With cash buying, you can buy only 250 shares with that money. Your trade value would be 250X400=₹1,00,000. You would need to pay brokerage of ₹ 500 (assuming brokerage rate of 0.5%).
Suppose the stock prices move higher by 5% in near future. The share price of this stock would be now ₹ 420.
With that trade you end up making a profit of 250 X 20 = ₹5000. Your net gain would be 5000 – 500 = ₹ 4500 or 4.5% of your capital.
With margin trading, you have two options as we talked above; broker mode and client mode.
With the broker mode in intraday trading, you can buy nearly 5000 stocks on margin. With the client mode, you can by nearly 3 times the stocks or 750.
We go with the client mode stock margin trading. Now your trade value would be 750 X 400 = ₹3,00,000. The brokerage paid would be ₹1500 (with same rate as above).
If you expect the price to hit the target in a week or so, you can simply buy 750 shares in margin. When your targets are met, you now make a handsome profit of 750 X 20 = 15000.
The net gain would be 15000 – 1500 = ₹13500 or 13.5%. It is 3 times of the profit you would have made with cash trading.
Is Margin Trading Good or Bad?
So is Margin Trading a good idea?
We talked above that it is a double edged sword. The cash leverage factor works both ways here. So margin trading can be good or bad depending upon how you approach your trade.
As with profits in case of a good trade, losses also mount up significantly if the trade turns unfavourable. That way it can be highly destructive also for your savings bank account.
A trade taken after proper research and thought process makes the probability of it going in your way significantly higher.
However, there is always a risk associated with stock markets. If you want to make money in stock markets, you have to take that risk.
Trades with good risk reward ratio can lead to swelling up of your bank account quickly. The profits are multiplied taking into consideration the limited capital employed for Margin Trading.
To make a trade work your way, it is good idea to give markets some time.
In intraday trading, the time is very short. With high cash leverage, although you can make big profits but the probability of losses also remains high due to high volatility or noise of daily price action hitting your stop loss.
You can make margin trading good for you by giving it time.
It is better to work as a positional trader with margin than a day trader. Although risk still remains, but as your stop loss is wider as compared to intraday trade, the risk of being it hit is minimized.
How to Buy Stocks on Margin ?
With the easy availability of an online trading account, buying a stock on margin is very simple process to follow.
1. Log in to your trading account.
2. Go to the equity section in the account.
3. Look for an option to place order.
4. Choose the stock you want to buy in margin.
5. Select the product as Margin out of Margin/Cash and the stock exchange where you want to trade.
6. Choose the desired quantity of the stocks you want to buy on margin.
7. Choose the type of order as Market order if you want to buy the stock at current market price or as Limit Order if you want to buy it at a price of your choice.
8. Place your Buy Order.
9. The Margin Amount required for the trade would be allocated from your savings bank account to your trading account.
After the order is executed the stocks would be displayed in your account under Margin Position. Never forget to put Stop Loss to any of your trade.
Advantages of Margin Trading
Margin Trading offers many advantages over cash trading :-
1. It provides you cash leverage when you are short of cash but still want to take big trading position.
2. Margin trading helps you make big profits with the available cash as compared to cash trading.
3. You become eligible for dividends declared by the company when you hold the stocks in margin under Pending for Delivery. So this is your additional gain apart from the profits you make if you are buying stocks on margin and keep holding them till ex-dividend date.
4. You can convert your margin position to delivery when you have funds available by paying the required extra funds. That is possible only when you are buying stocks on margin and not short selling.
Risks of Margin Trading
Margin trading, though, has many advantages but it is not without risks associated with it.
1. Biggest risk is associated with the big advantage it offers to traders. If the profits are big, the potential of trading losses is also big. You can loose money fast in your savings account.
2. Your trading position may get closed automatically due to shortfall of minimum margin in case of sharp decline in stock prices. You would need to keep an eye on margin requirement raised by your broker.
3. As the stocks are not in your demat account, you do not become eligible for bonus shares if any announced by the company. This is available only if you are buying stocks in cash.
Margin Trading vs Futures Trading
You must be knowing that Futures Trading also provides cash leverage for trading purposes. Futures trading also allows traders to play the market both ways; for long trades as well as short selling.
So, how they are different from each other?
It is true that Futures trading gives much more flexibility to a trader. However, the risk with Futures trading is much higher than margin trading.
This is because the cash leverage for Futures is much higher than Client Mode Margin Trading.
Moreover, Futures trading can be done in predefined Lots only.
A Lot is fixed number of stocks. A Lot size may comprise 50,125, 250, 500, 750, 1000, 1500, 2000 or any number of stocks depending upon market price of that stock.
With Margin Trading, you can buy any number of stocks as per your comfort level or requirement.
With Futures trading, one has to rollover the position to next month after contract expiry if one keeps to maintain trading position. There is no such obligation in margin trading.
Brokerage incurred with Futures Trading is much lower than the margin trading but the risk outweighs the low brokerage advantage.
So what you have understood till now?
We can easily conclude that for stocks, buying on margin and holding them is more rewarding than cash trading or intraday margin trading.
The later may look more lucrative but it takes a heavy toll of you.
With intraday trading, you may have winning trades as well as loosing trades. Gains are small. Then there are brokerage charges to add up. Last but not the least is the fatigue you get with margin trading in intraday.
You may calculate it yourself. Just calculate on your earnings from intraday trading on monthly basis. Then compare it next month with earnings you get from a positional trade in margin trading
You would find out that you made more money buying stocks on margin and holding them than alone cash trading or intraday trading.
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The Margin Trading Mystery Revealed