Margin trading in stock market is a highly rewarding strategy for stock trading. You can earn bigger profits with limited cash in your trading account. Traders can make money in bullish and bearish markets equally using margin trades.
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, first you learn how to make a strategy. 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 trading opportunity to pass on? Or you would trade with that little available cash and be satisfied with meagre profit? Well, here is a product you can use to make money trading stocks even with limited cash! This is margin trading!
With margin in stock market, you can trade in large quantities of stocks even if you have small money in your trading account through cash leverage. Moreover, traders can also make money in falling markets by short selling with margin trades. However, leverage trading stocks has its own disadvantages and risks too.
What is Margin Trading
Margin means borrowed money. You borrow money from a broker to buy shares or short sell the shares for trading. For borrowing, you would need to pay a certain percentage of the total trade value to the broker. This payment is called as Initial Margin. Initial margin can be anywhere from as low as 5% to as high as 20%.
Here is a buying on margin example illustration. Suppose, you want to buy 1000 stocks of any company. The current price of the stock is ₹100. Normally, you would need to have 1000 x 100 = ₹1,00,000 cash in your trading account to buy shares. However, with margin being 20%, you would need only ₹ 20,000 as initial margin amount to buy those 1000 stocks under margin trading.
For trading on margin, you need a margin account. We can define margin account as a brokerage account which allows us to borrow money from the stock brokers to buy shares in large quantities with small cash or for short selling the stocks.
When you open a demat (dematerialized) account with a broker, it has a delivery trading or investment account and a margin account. If your margin trading account is not enabled, you can get it enabled by agreeing to the terms and conditions. Otherwise, you can easily open a margin account by signing rights and obligations documents and submitting the residence and identity proof documents.
In this time of internet services, you can easily get an online trading account with margin facility. You do not need to go anywhere to borrow money for margin stock trading. It is all available on your desktop in your trading account.
Now that you have initiated a margin trade by paying an initial margin. There is certain amount which you need to maintain with the broker to keep your trade open. This is called as the Minimum Margin. In case of trade moving in unexpected direction, the minimum margin may shortfall. Then you get a call from your broker through an email for the minimum margin requirement. This is the ‘additional margin required‘ to keep the trade open and avoid it being closed by the broker.
To understand margin trading better, see example below where I had a margin buy trade in my trading account. I bought Dabur India stocks in 1000 quantity. The amount blocked in my account as initial margin was ₹1,13,938.02. My average buying price was ₹421.99 per share. The current market price for the stock is ₹433.45. The minimum margin requirement for my trade was ₹400,471.02 at that time. As my trade was moving in expected direction (profiting), I already had Available Margin Amount ₹433450. So, additional margin required showing in my account is ₹0.00.
Maintenance margin requirement is the margin money needed to keep your trade going on or open. Not being able to maintain the margin requirement 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. Here, you get maintenance margin call from your broker through an email to add the required deficit. If the stock price stay around there or starts rising, then there is no increase in minimum margin.
The same is true for short selling of stocks. It can be done in margin only. You can not do short selling in cash trading.
You need to pay margin interest rates if you are buying shares on margin and holding them overnight. The margin rates vary from broker to broker. The margin trading interest rates are listed alongside when you place an order to buy stocks on margin. There are no margin rates for using margin in intraday trading.
Buying securities on margin is not limited to stocks and shares only. Some stock brokers also provide margin for option trading (option plus) also. Buying options on margin allows you to buy multiple lots of option contracts for small cash to make the most of a good trading opportunity. Selling options (option writing) normally requires more money to trade even one lot of option contract. However, using cash leverage, margin required to sell options is very less. It can be as low as 20% of the total trade value.
Advantages of Margin Trading
Trading on margin in stock market 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 finance helps you make big profits with the available cash as compared to cash trading when you trade in large quantities of stocks.
3. You become eligible for dividends declared by the company for the securities held in margin. So this is your additional gain apart from the trading profits you make if you are buying dividend 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 stock on margin and not short selling.
Risks of Margin Trading
Margin, 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 lose 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 bought under margin 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 and stocks are present in your demat account.
4. Margin borrowing rates are the extra expenses in addition to the brokerage rates. The more long the securities held in margin, the more are the margin rates.
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 for margin buy.
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.
Is Margin Trading A Good Idea?
We learnt that margin trading in stock market allows us to trade in larger quantities of stocks with limited trading capital in our trading account through leverage trading. Trading big quantities multiplies our potential profits several folds. This is really a big advantage for small retail traders to earn more profits.
Stocks bought under margin are eligible for dividend payouts announced by the company. Buying larger quantities of stocks with small investment entitles you to receive more dividend payments if announced by the company during holding period.
Best stocks for margin trading are the stocks expected to move in favourable direction in short period of times as well as the dividend yielding stocks. You can make the most of limited cash by trading these stocks for decent gains.
With leverage on stocks, you can also use the available limited capital to trade in more than one stocks instead of exhausting the whole capital in single stock trades. This makes margin trading really a good idea.
However, cash leverage is a double edged sword. The cash leverage factor works both ways here. Trading in large quantities exposes to big trading losses. You can lose money fast. Moreover, margin facility also involves margin interest rates on the borrowed money. Margin rate is the interest rate charged by the broker when the trade is carried forward to next trading day. Margin rates adds up to the big losses, higher brokerage charges with big trades. Hence, consequential losses can be more than just difference between selling and buying prices.
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 stock trading good for you by allowing some valuable time to the trades.
It is better to work as a swing trader or 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.
Margin Trading vs Futures & Options Trading
You must be knowing that futures and options trading also provides cash leverage for trading purposes. It allows traders to play the market both ways; for long trades as well as short selling. With margin trading explained above sharing similar features with futures and options trading, which should be better for trading purposes?
It is true that futures & options trading gives much more flexibility to a trader. However, the risk with futures & options trading is much higher than margin stock trading.
This is because futures & options 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 Futures trading, one has to rollover the position to next month after contract expiry to maintain trading position. Options become worthless at expiry and you would need to take new trading position if you want to trade further.
There is no such obligation in margin trading. You can buy any number of stocks as per your comfort level or requirement in margin.
Brokerage incurred with Futures Trading is much lower than the margin stock trading but the risk outweighs the low brokerage advantage.
Margin in stock market offers a great facility to small pocket traders to trade in large quantities of stocks and earn large profits with small cash. You can use margin trading and short selling to make profits in falling markets. Buying stock on margin and holding them entitles you to earn the dividends and get additional income other than trading profits.
However, margin trading in stock market is also associated with larger trading losses due to cash leverage. There is additional expense of margin interest rates when we carry forward our position to next trading day. But using margin wisely with appropriate risk reward management, it can be highly rewarding to you.