Margin trading is a concept that allows investors to trade in equities by paying only a part (or margin) instead of full consideration value of the trade. This is enabled by a broker who funds the balance amount and charges interest to client.
The margin can be settled later by squaring off open position. Since there are many factors involved in the process, margin trading facility is practiced more often by seasoned investors than a novice. It takes a fair amount of time to understand the workings of margin trading, so it is always advisable to consult a professional financial or investment planner.
In simple words, Margin Trading is a facility provided by stock broker to clients whereby a client can buy or sell securities without paying 100% amount upfront towards purchase consideration or 100% shares that are sold. The part paid by the investor is called ‘Margin’ and the portion that is not paid is the leverage given to client by the broker.
Investor can pay the margin in form of cash (not hard cash – by way of bank transfer) or by depositing securities. Securities provided as margin are also known as ‘Collateral’.
Let’s take an example. You want to buy 100 shares of ABC Limited which is priced at ₹1,000 per share. The transaction value will be ₹1,00,000. Assuming there is nothing like margin, you will need to pay ₹1,00,000 to broker at the time of placing your buy order. Now, assuming your broker is providing 50% margin facility, you can invest in those shares by paying just ₹50,000. The balance amount is funded by the broker and squared off at settlement.
So, in the context of stock markets, margin is the total amount or extent of leverage available to an investor. There are certain rules prescribed by stock exchanges which need to be followed by your stock broker regarding the extent of margin that can be available to you. This may vary from stock to stock and from time to time.
Margin trading helps investors to buy securities of their choice without paying the full amount of money beforehand. They can make money when the earning from the trade is more than the margin. Margin Trading helps in increasing trade volumes. By enforcing margin requirements, exchange controls the trading activity in the market. Margin requirements are used by exchanges to manage settlement risks.
There are different types of margins applicable to equity trading in India. Each has its own rational. Let’s have a look at the types of margins for cash segment –
A) Value at Risk (VaR) Margin or Initial Margin (IM)
It is intended to cover the largest loss that can be encountered on 99% of the days. For liquid stocks, the margin covers one-day losses while for illiquid stocks, it covers three-day losses to allow the exchange to liquidate the position over three days.
B) Extreme Loss Margin (ELM) Margin
It is a second line of defense to cover extended losses that go beyond 99% risk which is covered under the VaR margin.
C) Mark to Market (MTM) Margin
MTM is calculated on all open positions of an investor on any trading day as difference between transaction price and the closing price of the share. If the closing price is less than the transaction price, then the notional loss needs to be paid to the exchange.
D) Peak Margin
Peak Margin is the minimum margin that must be collected by brokers from their clients in advance of placing any intraday / delivery order in the Cash and Derivatives segments.
Clearing corporations take at least four random snapshots of all margin status during the trading session. Brokers gets margin calls from clearing corporation as per their aggregate trading volumes etc. They need to fulfil their margin obligations and report to clearing corporation. The highest margin requirement that emerges from the different snapshots would become the ‘Peak Margin’ for the day. This peak margin is then compared with the available margin of investors. Penalty may be imposed by Clearing Corporation on broker if peak margin requirement is more than the available margin.
There have been important changes with respect to peak margin requirements of recently. In order to make markets safer for investors, SEBI directed stock exchanges to increase the peak margin in a phased manner. As can be seen from the graphic below, with effect from September 1, 2021, peak margin requirement is 100%.
The increasing margin would logically affect regular traders because of their reduced ability to leverage their funds or having to raise additional funds to continue trading. In the earlier system of calculating margin requirement at the end of the day, traders could sell shares of a certain value and buy another lot of shares of the same value due to the net availability of margin. Under the new peak margin system, the margin required for a particular transaction could change throughout the day. This needs investors to maintain additional funds and reduce the risk from intraday transactions.
1. Margin can be paid by depositing amount in designated bank account of broker.
2. Margin can also be paid by creating a ‘Margin Pledge’ in favor of the broker.
Modes of providing Margin - Funds
3. Free and unencumbered Balances (funds and securities) available with the Broker in different segments of the Exchange.
4. Bank guarantee issued by any approved bank and discharged in favor of the Broker.
5. Fixed deposit receipts issued by any approved bank and lien marked in favor of the Broker.
6. In case client buys a share on T day with upfront payment of applicable margin and if client sells the same shares on T+1 day, then
a). Client needs to pay separate margin for sale trades also, as Buy and Sell trades are executed in different settlements.
b). Broker may choose to pay for the buy position of client (buy value – margin paid by the client) and collect the payout of shares on T+2 day in Client Unpaid Securities Account (CUSA).
c). Broker may deliver the shares from CUSA on T+3 day towards pay-in for sale trade on T+1 day.
d). Broker may also choose to post the buy and sale value of shares to client’s account upon execution of sale transaction, which could be used towards margin for subsequent trades of the client.
e). Securities received in pay out and available in CUSA account (reduced by the minimum 20% haircut) after adjusting any debit balances in client ledger shall be considered for collection and reporting of margin.
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