What Is Stock Margin?
In the realm of finance, margin trading refers to the practice of borrowing funds from a broker to purchase stocks. Stock margin is the amount that you take on credit from your broker to invest in a particular stock/security. The margin permitted depends on your broker and on the stock.
This mechanism allows investors to acquire more shares than they can afford with their own cash, effectively amplifying their purchasing power. The borrowed funds, known as margin loans, are secured by the stocks purchased, acting as collateral for the loan.
The mechanism of stock margin allows you to utilise leverage, that is, use loaned funds to gain profits that are potentially higher than the interest to be paid on the loan. The leverage inherent in margin trading can significantly enhance returns when stock prices rise. However, this same leverage can exacerbate losses if stock prices decline. This risk arises because investors are responsible for repaying the margin loan regardless of the stock’s performance.
How Does Margin Trading Work?
Let’s consider an example to understand the working of margin trading. Assume you have ₹10,000 and wish to buy Stock A worth ₹20,000, the share price of which is ₹100. You can invest in Stock A using ₹10,000 of your own capital, and borrow the remaining ₹10,000 from your broker. That means you could buy 200 shares of Stock A and own ₹20,000 worth of that stock. Due to this, your account balance would be = ₹20,000 (Stock Worth) – ₹10,000 (Loan from Broker) = ₹10,000.
If Stock A goes up from ₹100 to ₹110, then that means it has increased 10% more than the price at which you invested in the stock. This makes your 200 shares worth ₹22,000. Due to this, your account balance would be = ₹22,000 (Stock Worth) – ₹10,000 (Loan from Broker) = ₹12,000.
Had you not taken the loan, you would have gained only ₹1,000 instead of ₹2,000. Your gain would have been only 10% instead of the 20% (i.e. 2,000/10,000) that you have earned now. This shows how a 10% increase in stock price magnified a 20% increase in your account value.
However, this works the other way, too, i.e. in case of losses.
Now assume that Stock A drops from ₹100 to ₹90. This means that the price at which you purchased Stock A has dropped by -10%. At this point, your 200 shares would be worth ₹18,000. Due to this, your account balance would be = ₹18,000 (Stock Worth) – ₹10,000 (Loan from Broker) = ₹8,000. This means that a -10% decline in the price of Stock A magnified to a -20% decrease of your account value.
Advantages of Margin Trading
- Stock margin helps investors buy larger volumes with smaller amounts, thus amplifying leverage. This can help them profit out of even minor positive market movements despite having low capital in their trading account.
- Helps investors who would like to invest for the short-term but have a shortage of funds. For example, to take positions during favourable market fluctuations.
- Stock margins help you diversify your portfolio by allowing you to allocate capital to a broader set of assets.
- Margin accounts allow you to engage in short-selling, i.e., you can benefit from falling stock prices by borrowing and selling them.
However, just as Margin Trading magnifies profits, it could also magnify losses. Also, since you have taken credit from your broker, you need to pay interest as agreed upon.
Now, if you invested ₹1,00,000 in Stock A, using Margin Trading, but the value of the Stock dropped to ₹85,000, remember, that you will have to incur the loss on investment as well as pay the broker interest on the borrowed funds. Hence, trade wisely.
Points To Remember If You Want To Try Margin Trading
- Be cautious while investing: Margin Trading is meant for responsible investors. Always remember that Margin trading can augment both profits as well as losses. So, plan your investment choices, keeping in mind your risk-taking capacity. Also, you still need to meet the stock margin requirement for your position. Hence, always ensure that you have sufficient funds to withstand any momentary move against your position and meet the margin call.
- Use credit sensibly: It is advisable to borrow less than the full amount you are permitted. Especially if you are new to Margin Trading, you should begin with small amounts and increase your investment value gradually.
- Pay back credit at the earliest: Margin is very much like a loan, and you have to pay interest on the borrowed funds. The interest charges are applied to your account until you settle the credit you have borrowed. As interest charges continue to accrue, your debt level increases. As debt increases, the interest charges increase, and so on. Hence, it is recommended to settle the outstanding at the earliest so that you don’t have to pay additional interest.
Conclusion
If you enjoyed reading this article, do not forget to check out the Angel One blog where you can stay updated with the latest stock market news. If you are new to the stock market, open a Demat account with Angel One today!
FAQs
What is the margin in the stock market?
In the stock market, the margin is the money borrowed from a broker to purchase an investment. It allows investors to buy more stocks with less of their own money, amplifying both potential gains and losses.
Is buying stock on margin too risky?
Buying a stock on margin increases the size of your position. Therefore, the gains and losses become larger as well. This does increase the level of risk to your portfolio. The higher the margin compared to your own capital, the higher the risk.
How is the stock margin calculated?
Stock margin, i.e. the margin required to buy a stock, can be calculated by multiplying the number of shares by the price as well as the margin rate. You can use Angel One’s margin calculator to calculate F&O margins.
How to do margin trading on Angel One?
To avail the margin trading facility on Angel One, simply use the ‘PAY LATER’ mode on your orderpad.
