Ajay wants to indulge in the stock markets but does not have enough funds to initiate a trade. On one occasion, he shared his problem with his friend Atul, a successful stock market trader. Upon hearing Ajay’s situation, Atul asserted the former that he need not have a big amount of funds to trade. Instead, he could just pay a smaller amount called margin and trade in shares of larger amounts.
Here is what Atul explained:
With margin trading, you can buy a big lot of shares despite not having enough funds to afford the same by borrowing the funds from your broker. This can be done by paying a margin, which is a small part of the total value of the shares bought.
This margin can be settled later when you square off the position. If your profit is higher than the margin, then you make a profit on the trade else you lose money.
The amount of margin paid and the repayment duration varies for different stock brokers. But for margin trading, you need to first open a margin account with your broker.
To open a margin account, you need to place a request with your broker and might require you to pay an amount beforehand. This amount paid to open a margin account is called minimum margin. You have to maintain this minimum margin throughout in your margin account.
In case you fail to maintain the minimum margin in the account, the trade automatically gets squared off. Squaring off is mandatory after each session.
If you are looking forward to making a delivery order by converting the trade, then you need to keep the cash ready. This would be equivalent to the value of shares you bought plus brokerage fee and additional charges.
In cases where you fail to do so, your shares in trade will not be converted into a delivery order; instead, the position would be squared off.
While margin trading is the easiest way to earn money without investing a huge amount, it comes with its own set of rules, which must be heeded without fail.
Buying Stocks on Margin
Similar to the concept of margin trading, you can also buy stocks on margin. In this case, the stocks or securities which you buy act as the collateral. Here, too, you need to pay the margin amount, which is a percentage of the total value of the order and the minimum margin while opening the margin account.
Based on the credit repayability, the minimum margin and maintenance margin values are decided. When the value of stocks falls below a minimum margin, the broker would ask you to maintain the minimum balance of your margin account. You could do this by depositing additional cash or by selling the securities to compensate the amount.
The Bottom Line
Undoubtedly, margin trading and buying on margin help budding traders and investors to make stock market trades and investments with low funds. But traders must also carefully pick their deals because the loss is just as much amplified as the profit. Evaluate your risk appetite before trading for best results even during tough times.
If you are in a similar situation where you lack enough funds to make a big trade, then you too can opt for margin trading or buy stocks on margin like Ajay.