Stock market is a vast subject. Learning to invest in stocks presents many possibilities and various investing strategies could be employed to on an equally large number of stocks. Similarly, there are many types of orders one can place in the markets such as delivery based order, order in the F&O market, margin order etc.
The scope of Intraday margin trading in the Indian stock markets
Margin trading is a leveraging mechanism in which your money becomes worth more than its true value. Put differently, it increases the buying capacity of the investor as he can buy shares by making only part payment of the total order value. Margin trading can be employed on a short term basis generally only for a day.
The buyer only pays 20-30% of the stock value to purchase the stock. His risk is that in case the stock price falls by 20-30% (i.e. the margin amount), then he will be forced to either deposit more money in his margin account or he will suffer a loss to the extent of his entire margin deposit (i.e. total capital deposited).
If the stock price increases (or keeps increasing) he can hold on to the stock until the end of the trading session.
Let’s take up an example to understand this:
Investor has an amount of Rs. 1000 with him. If he wants to trade on margin, he just has to pay a certain % of the price of the stock (the actual margin amount to be deposited differs based on the underlying stock). Let’s say he invests in a share, the value of which is Rs. 50 and the margin requirement is 20%. By trading on margin, he will be able to buy 100 shares (i.e. the total order value for 100 shares being Rs. 5000, he will have to pay only 20% of this value to take this position).
Had he invested Rs. 1000 to buy the stock in cash market (i.e. on delivery basis) he would have got only 20 shares and hence his profit from increase in share price would have been limited to that extent. The risk is that in case the stock price falls from Rs. 50 to Rs. 40, he will lose his entire capital.
In short – margin trading brings in more profit with lesser investment but entails higher risk.
Certain Limitations with Margin trading:
1. Margin trading is not available for all stocks. Particularly, you cannot trade on margin in penny stocks, initial public offerings, and over-the-counter bulletin board securities.
2. You need to maintain the margin amount at all times while you have a position in the stock. Hence you must keep a certain fixed amount in your bank account. If you fail to maintain that amount, then the broker would sell the stock to recover his amount.
Keep in mind that while margin trading can amplify your profits, it requires extra cautiousness while trading. For a more detailed analysis on this aspect, visit our post on – Panic selling and margin calls.