Have you ever thought of how exactly margin trading works and how you can use it to your benefit? With this article, we aim to answer all the questions about margin trading and define margin trading for you.
Before we move to margin trading and all about it, let’s first understand what margin means and how is margin trading defined.
A ‘margin’ is known as the equity amount of an investor. Buying with margin or to margin refers to using a sum that a person may buy from a broker to buy or invest. Through this method, an investor can buy and invest in more things than the initial sum in their account. A margin account is made for the broker, which lends the investor the money needed to buy more securities.
Smart use of margin in buying can give you more financial stability and security. At the same time, the initial sum in your account acts the same way as collateral for a loan. The losses and profits that involve margins are often felt in excess.
What is margin, and what is the definition of Margin Trading?
Margins are often used when buying securities that provide more financial benefits and profits than the interest that needs to be paid. Margin trading refers to buying stocks that one may not be able to afford. The broker then pays the margin to buy that particular stock or security.
With regards to investors, Margin Trading helps them hold more stocks and places within the market. These may add to the places in the market, they owned before. In the matter of margin trading, investors are free to buy an investment or security by paying only a certain amount of the actual value, the rest of which is paid by the broker.
Margin trading helps the investor earn a higher profit. Losses, if experienced by the investor, are also excessive due to margin trading. The margin is then returned with interest to the broker when the profits are earned.
Margin trading also proves very helpful when an investor hopes that the investment’s earnings, i.e. the ROI, is more than the interest paid on the loan amount.
Why Margin Trading is Good
In simple words, if an investor has an initial margin need of 70% for their margin account and wishes to buy securities worth ₹10,00,000, then their margin would be ₹7,00,000 and the rest, i.e. 30% or ₹3,00,000 could be borrowed from the broker.
Margin trading can prove profitable in the following ways:
Flexible Trading: Flexibility in trading is possible when an investor can expand and look for more investment opportunities, even with a limited amount. This can, to a great extent help investors if they take up timely market opportunities and invest in them.
Expand and diversify the portfolio: Margin trading helps an investor diversify their portfolio. This can be done when the investor holds a lesser stock position and can use the margin buy.
Simplify the process: No extra fees or paperwork is needed to use margin trading.
Tax deductions: Margin loans need a certain interest rate set by the broker and the investor. These interest rates may be deductible as taxes against the income from the investor’s net investment. Taking the help of a tax advisor can prove helpful in this case.
Increase in current income: Cash inflow is more, in turn increasing the investor’s current income.
Risks involved in Margin Trading
Some risks that come with margin trading are:
Bigger losses: Margin trading may have big losses as it involves investment by more than one person too.
More charges: The investor may need to pay separate charges in the form of interest and account fees.
Margin calls: Margin calls are made when a Margin account runs out of some account balance. This is common with trading accounts that incur heavy losses due to an investment. These also need more investments to ensure some account balance is always maintained.
Liquidations: Suppose an investor fails to keep their end of the bargain and maintain the agreement. In that case, brokers are given the right to take any lawful actions like liquifying the investor’s assets to cover the sum of the margin first paid by the broker.
Some practices to adapt during Margin Trading
While there may be risks that come with Margin Trading, here are three things that can help one gain from Margin Trading:
Be picky about investments: Investing wisely is an essential part of margin trading. One must be careful as losses and profits are affected by margin trading. Investing wisely refers to investing in opportunities that will provide a larger ROI than the investor’s interest amount on the loan. Margin calls must also be considered when investing in opportunities.
Start small: When margin trading, an investor must be mindful not to borrow the full amount limit from the broker. The investor must try testing the investment with a small amount first, calculate their profits and then decide whether to continue the margin trade with the broker or not.
Consider the period of the margin trade: Margins are like loans; an investor must pay interest on the amount borrowed from the broker. Margin trading for a shorter time to avoid paying high interest on it is viewed as a best practice for financial profitability.
By now, you must have gained a better understanding of margin trading. When margin trading, it is best to plan and look for profitable investment opportunities. Market knowledge and expertise are also good add-ons.
Financial experts at Piramal Finance are trained to provide guidance and help one make the best decisions to help achieve their financial goals. Make sure your financial knowledge is up to date on essential services and products, such as personal loans and stock trading, by reading the informative blogs on our website.
Also Read: New Income Tax Rules for NRIs