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5 things to know about Margin Calls
Ever noticed the domino effect on a stack of cards? You push one card and the rest fall in a loop. Something like this often happens in the Stock Market too. You may have noticed that the market fall steepens suddenly.
There are many reasons for this like selling to cut trade losses or a panic sale. One of the most important reasons, however, is a margin call. This is one of the key reasons behind the market’s continued fall in the last many sessions. Read on to understand further.
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Margin Trading
Retail investors form only a small part of the daily stock market transactions. Most of the buying and selling is conducted by traders. Moreover, these trades have high values – stocks worth lakhs and crores of rupees. It would be difficult to have access to so much liquid money to conduct these transactions. This is where ‘Margin Trading’ comes in. You can opt for Margin service from your Broker and buy/sell stocks worth 10-14 times the money in your account. For example, you buy/sell stocks worth Rs 50,000 even though you only have Rs 5,000 in your account.
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Safety Net for Lender
No bank or lender gives money without any collateral. This applies to Margin money too. It is, after all, lending activity by your Broker. In this case, the Margin acts as the collateral. This is a safety net for the lenders in case of losses.
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Mark to Market
This Margin is calculated as a percentage of the value of trading. Every day, as the value of your stocks changes, so will your Margin account balance. For example, suppose you have a stock position worth Rs 2 lakh and your broker needs 25% or Rs 50,000 as Margin. The next day, the stock’s value falls to Rs 1.8 lakh, then Rs 20,000 gets deducted from your Margin balance. This is called 'Marking to the Market’.
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Margin Call
Sometimes, it may so happen that the margin balance is not enough to make up for the loss in value. In such a case, the Broker will trigger a Margin Call. You will then have to deposit more money in your Margin account. In the above example, the value fell 10% on Day 1 leading to a Margin balance of Rs 30,000. Let’s suppose this continues further and the value falls another 15%. Then, the Broker will deduct Rs 27,000 from your Margin account. You will end up with only Rs 3,000 in your account. The Broker may then sound a Margin Call.
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Margin Call Selling
Margin Call acts as an alarm bell for you to credit more money in your Margin account. Yet, it may so happen that the required funds are not available on such a short notice. In such cases, the Broker may sell off your shares to cut his losses. This is called as Margin Call Selling. This is a key reason why the day’s losses jump in a short span of time
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Rs 2.03 lakh crore
The promoters of NSE-listed companies pledged shares worth Rs 2.03 lakh crore in 2015. This value is up 14% from the previous year. In fact, this is the highest companies have pledged in seven years. Promoters usually pledge shares to raise money. Such pledging can also cause selloffs, just like Margin Calls. If the stock value falls, the lenders – like banks and NBFCs – may ask for extra collateral. If that is not possible, then they could sell the shares off. This could cause the market to fall further.
