What is Margin Money?

  •  4 min read
  • 0
  • 27 Sep 2023

In derivative trading, "margin" refers to the amount of money or equity an investor must maintain in their brokerage account to facilitate trading with borrowed funds. These funds function as security, protecting against potential losses that might occur during the trading process. Engaging in margin trading for derivatives enables investors to increase their exposure to the underlying assets.

Key Highlights

  • Margin borrowing provides flexibility, allowing investors to benefit from returns without investing the entire value of the security, known as leverage.

  • To meet the margin call, the investor must either deposit more funds or sell securities to restore the required equity level.

  • Actively monitoring positions is important in margin trading to respond quickly to market fluctuations.

Margin and margin trading play significant roles in the stock market, providing investors with opportunities to increase their investment positions. Margin is the amount of money or securities that an investor must deposit with a broker to open or maintain a trading position. It acts as collateral and ensures that the investor has the financial capacity to cover potential losses.

Margin trading involves using borrowed funds, usually provided by the broker, to increase the size of a trading position beyond the investor's cash balance. This leverage enables traders to potentially increase their returns.

The initial margin is the cash deposit necessary when initiating a new futures position, calculated as a percentage of the entire contract value. Whether one opts for a long or short position in futures contracts, the requirement for the initial margin remains applicable in futures trading. The calculation of the initial margin depends on a percentage of the total value associated with the futures contracts, and this percentage varies based on the specific futures market being traded. If your account has an initial margin requirement of 50%, and you intend to buy a security valued at Rs 10,000, your margin amount will be Rs 5,000.

While margin borrowing offers the potential for enhanced gains, it requires a careful assessment of market conditions and a thorough understanding of the associated risks. Some key advantages and disadvantages of margin borrowing are explained as follows.

Advantages Disadvantages
Using leverage has the potential to generate higher profits.Leverage can also lead to increased losses.
It enhances the borrower's flexibility, allowing them to buy a greater number of securities than their initial capital would permit.It may result in account fees and elevated interest charges.
It offers greater flexibility compared to other loans, and regular EMI payments may not be required.In case of margin calls, the borrower might need to contribute additional funds to cover the losses.
A self-reinforcing cycle may boost the value of collateral, allowing the borrower to experience increased leverage.If forced liquidation occurs, the selling of securities can lead to an overall loss.

Suppose you deposit Rs 10,000 into your margin account, which allows you to borrow Rs 20,000 as you've already covered 50% of the buying price. If you acquire stock valued at Rs 5,000, you still have Rs 15,000 of remaining buying power in your account, with enough cash to fulfil the transaction without utilising your margin. The buying power of the margin depends on the security's value. Given that the values of securities fluctuate daily, the buying power will also vary accordingly.

The income statement of a business serves as a valuable tool for calculating different accounting margins. These margins, derived from the disparities between expenses and revenue, offer insights into the business's health across immediate, medium-term, and long-term periods.

  1. Gross Margin

The Gross Margin is calculated as the variance between Sales and the Cost of Goods. This margin provides an initial snapshot of the profitability of the core business operations.

  1. Operating Margin

The Operating Margin is determined by deducting both the cost of goods and operating expenses from Sales. It digs in deeper into the operational efficiency and profitability of the business.

  1. Profit Margin

The Profit Margin represents the difference between Sales and all incurred expenses. This comprehensive margin offers a holistic view of the net profit earned by the business, making it a crucial metric for investors and stakeholders.

Engaging in margin trading is a complex process that involves notable risks. Risks associated with margin trading are explained as follows.

  1. Increased Losses

It's evident that engaging in margin trading has the potential to significantly amplify an investor's profits. However, it equally has the capacity to escalate losses, sometimes exceeding the initial investment amount. Some traders may perceive owing money to brokers as a more simple alternative to dealing with traditional banks or financial institutions, but the obligations incurred in this form of debt are just as binding.

  1. Margin Calls

A margin call occurs when a broker requests the trader to inject additional funds into a margin account until it reaches the mandated margin maintenance level. If the positions held by the borrower incur substantial losses due to underperforming securities, the margin account may fall below a specified threshold. In such instances, the investor must either sell a portion or the entirety of the assets in the account or contribute additional funds to meet the margin requirement.

  1. Liquidation

Subject to the conditions outlined in the margin loan agreement, a broker retains the authority to take corrective action if the investor fails to fulfil their commitment. For instance, if the investor cannot meet a margin call, the brokerage firm possesses the right to liquidate any remaining assets in the margin account.

Conclusion

Margin trading provides investors with leverage, enabling them to buy a greater quantity of securities than they could with their own capital. This increases both potential gains and losses in margin trading. Investing a margin of the total security value allows for the possibility of increased profits. Conversely, if the security's value decreases, the potential losses are proportionately significant. To optimise the advantages of this tool, investors should implement a carefully planned strategy. It's advisable to use margin trading for short-term investments and carefully select securities to minimise risks.

FAQs on Margin Money

Margin in stocks refers to borrowing money from a broker to purchase more shares than you could with your own capital alone. It's essentially a loan allowing investors to leverage their investments, potentially increasing gains and losses.

To engage in intraday trading, traders need to deposit at least 20 percent of the transaction volume with their brokers to access margin facilities. As an alternative, you have the option to utilize existing securities held in your Demat account as collateral.

Unused margin money is refundable. You'll get your full amount back if the margin amount is not used at all. However, it may not be fully refundable if it is used. The losses will be deducted from your margin deposit. You'll get back the remaining amount if there is any balance amount.

In such a scenario, you need to inject additional funds to meet the loan conditions set by either the broker or regulatory authorities. Failure to bring their investment up to the specified minimum requirements grants the broker the authority to liquidate your position to recover the owed amount.

The facility to withdraw the margin money from your trading account depends on the particular broker. Some brokers may offer it, while others don’t. If a broker provides this facility, you can place a withdrawal request and withdraw the used funds.

No, it is not compulsory to avail of margin money. It is only required if you want to enter a large position but don’t have sufficient funds.

Yes, margin money is different from collateral. Collateral is an asset offered as security for a loan, while margin money is a cash contribution.

Yes, the purpose of margin money is to allow investors to amplify their buying power and acquire more stocks than their own funds would permit

Failure to maintain the required margin may result in a margin call, where the investor must either deposit additional funds or sell some securities to meet the margin requirement.

While margin trading is possible for short-term investments, using margin money for long-term investments is generally not recommended due to increased risks.

Yes, margin money can be used in options trading, allowing investors to leverage their positions in the options market.

Enjoy Zero brokerage on ALL Intraday Trades
+91 -

personImage