Last week we got a query from Mr. X that he wanted to start trading in Stock Market. He has basic knowledge of Technical and fundamental analysis and already proven himself paper trading using dummy accounts. However, Mr. X does not have enough capital to start with. He is a fresh college graduate and do not have any other sources of income. His total savings is 20000 Rupees which he feels is too less to start trading. There are many individuals like Mr. X who are fascinated by the world of stock markets but do not enter into it as they feel they don’t have adequate capital. Almost every stock broker and exchanges have introduced the concept of ‘Margin Trading’ in order to solve this common problem.
What is Margin Trading?
Margin trading is a concept which allows you to buy more securities than what you can buy with capital in hand. It’s like a loan from your broker or exchange. For ex: with a capital of 20000 Rupees you can buy securities worth 100000 Rupees.
Which securities I can trade on Margin?
Almost every security can be traded on margin. It may be stocks, futures, commodities or currency. For cash market, generally brokers provide the margin and charge nominal interest for the same. While for Futures market, exchange provides the margin and there is no interest charged. Every broker and exchange have different margin policies.
How margin trading can be useful?
Take example of Mr. X. He has a capital of 20000 Rupees which he feels is not adequate for trading. But if he trades on margin, he can trade for as much as 10 times with this margin (depending on broker and order type). Now if he earns 2% profit in this trade, his total profit would be (0.02*200000) 4000 Rupees. This is 20% of his initial investment which is much greater than the returns he would get if he does not trade on margin.
Is there any risk involved with Margin trading?
Definitely there is risk associated with every reward. Since profit/loss is calculated on the entire traded amount, margin trading has the potential to wipe out your entire capital. In the above example, if Mr. X makes a loss of 5%, his total loss would be (0.05*200000) 10000 Rupees. So he would be left with half of his initial capital. Hence it is very important to put a stop loss and maintain good risk-reward ratio. Read our article on Risk Reward Ratio below:-
How can margin be calculated for various instruments?
Every broker has a span margin calculator tool in their website. Below is the link from Zerodha:
You can find the snapshot for margin calculator below. You can see that to buy 1 stock of TCS, you would need a margin of 181.65 Rupees. The actual price is 2421.95 at the time of writing this article. Thus, the margin requirement for TCS is 7.5%. This varies for different instruments. You may check it yourself in the link provided.
What is the margin requirement for Futures?
Every future instrument has different margin requirements depending on the exchange. Below is the sample margin requirement for different future instruments:
|Instrument||Lot Size||Closing Prize||Margin Required||Total Underlying Value||Margin %|
What is Margin Call?
Margin Call is a broker’s demand on an investor using margin to deposit additional money or securities so that the margin account is brought up to the minimum maintenance margin. This is issued when you have unrealized losses which is approximately 80% of your Trading capital. Few brokers automatically square off your open positions instead of issuing margin call.
Any final suggestions before I start trading on margins?
Margin Trading is a very useful feature but should be used wisely. One should always have stop loss in place to avoid margin call. Also, the amount traded should not be over 50% of your total trading capital. Margin Trading with a proper risk management will surely give an edge to your trading career.