What is Margin Buy and Margin Sell in Stock Markets?
What is margin buy and what is buying on margin? This is a frequently used term in stock markets and as the name suggests you can do margin buy or you can also do margin sell. Buying on margin, as the name suggests, entails paying just part of the amount that is payable for the purchase of shares.
Broadly margin trading takes various forms. You can do buying on margin via intraday trading, actually funded margin buying or you can also leverage futures to create a proxy of buying on margin. The key advantage of buying on margin is that you can take a much larger position than what your current financial capacity affords. Let us look at Buying on margin and also margin sell in greater detail as we go along.
What is Buying on Margin?
Let us understand what exactly Buying on margin, first and foremost. Let us conceptually assume that you want to buy 10,000 shares of the State Bank of India. Now, if you were to buy 10,000 shares of SBI in the equity market, it will cost you nearly Rs.33 lakh to take delivery of that stock assuming the approximate current market price of Rs.330 per share. In case, you have the requisite funds in your trading account, then there is no problem. But, that is normally not the case in most cases.
Now, what if you do not have the funds but still want to take the position? That is where Buying on margin and margin funding comes in handy. What does margin buy and margin sell imply and what are the risks associated with buying on margin? There are broadly two kinds of margin trading that you need to be familiar with. Remember, as we had said earlier, you can either pay a part of the sum and get leverage or borrow the balance amount by paying interest. The latter is the route if you want to enjoy the perks of stock ownership like dividends, voting rights, etc.
Let us first understand Buying on margin using intraday trading methods
This is also a form of funding but here the funding is not in cash but terms of limits offered by the broker. Intraday trading or trading for net daily zero positions is the most basic form of Buying on margin. Let us look at that in greater detail. If the trader wants to buy Infosys for delivery, it would cost a lot of upfront capital investment, However, if the trader agrees to buy the Infosys stock only for intraday trading, with the assurance that the position would be closed before the end of the day, he can get much better leverage on his money. This is the most basic form of Buying on margin.
However, in this case, the agreement is that the trade is only for the intraday purpose for which the broker permits the trader to pay a small margin instead of the full sum. For example, if the market price of Infosys is Rs.1,600 and you need to buy 2000 shares, then you need nothing less than Rs.32 lakhs. What if you have only Rs.8 lakhs? Can you buy the same position in Infosys? The answer is yes if you only do it for strictly intraday purposes. Any broker will give you a margin up to 4-5 times your margin money based on the volatility of the stock and the risk involved. These limits for intraday margins are defined by SEBI and brokers cannot distract too much from these margin specifications.
This intraday margin trading leverage is also based on volatility. For example, the limits will be higher for a stock like Tata Motors but lower for a stock like Yes Bank or IndusInd Bank; which are more volatile. To avail of this intraday trading margin, you need to specify at the time of placing the order itself, that you only want to buy the stock for intraday. You need to select MIS order to specify that it is an intraday order. If you also put a stop loss and profit target at the time of placing the order, it becomes a cover order/bracket order and can get a still higher margin from your broker.
There is an important condition you must adhere to. The condition is that these intraday trades must mandatorily be closed out intraday i.e., before the closing of trading on the same day it was initiated as otherwise, it would go for mandatory delivery. Brokers run their open position MIS at around 3.15 pm. If the trader has not closed the intraday position by that time, despite selecting it as an MIS order, the broker’s online RMS (risk management system) will automatically close the position. This is a risk as the RMS is normally agnostic to the price of a closure. Hence If you are using the intraday trade route, make it a point to close the intraday margin position by 3 pm latest.
The more important margin funding of delivery positions
This is the actual margin funding that we have been talking about. While intraday is a mirror of margin funding, you can get delivery positions funded by the broker. Since the broker cannot directly fund the position, it is normally the broker’s affiliated NBFC that funds the position. You take a position in the stock for delivery and you are not required to close out the position intraday and can carry it forward by just paying a margin. For example, if you buy Tata Steel, you pay a 25% margin to buy 10,000 shares of Tata Steel. Then, what about pay-in?
Next day morning at the time of the pay-in, the funding for the pay-in will be done on your behalf by the broker, for which you need to enter into a margin funding agreement with your broker in a standard format. Needless to say, the broker charges interest for the period that you use the margin. It is a short-term funding facility and the margin funding rates would be close to what a typical NBFC would charge for such back-to-back loans. The margin account is closed when the shares are sold and the proceeds are used to first repay the margin funding loan with interest. Hence when you take margin funding, it is very important that you also impute the interest cost into your break-even calculations.
What is Selling on Margin?
Just as you pay margins on intraday buying, you also have to pay margin on intraday selling. That is because there is an intraday open position and the risk could multiply if the price movement is against. That means if you sell and the price goes up, your risk could get magnified. That is selling on margin. You can also do selling on margin for delivery, but that is done through a more complex process of stock borrowing using the stock lending and borrowing mechanism of the stock exchange.
Buying and Selling on Margin Example
Buying 1000 shares of X stock when you don’t have enough funds or selling 1000 shares of Y stock when you don’t have the stocks in your Demat account are both examples of buying and selling on margin respectively. In both cases margins are payable. In the former case, the cash is funded while in the latter case, the stock is funded. You can also do margin buying and margin selling inequities using the intraday trading route. In this case, similar upfront margins apply for buying on margins and selling on margins with the average leverage being around 4-5 times.
Frequently Asked Questions Expand All
Margin for selling is calculated based on an exchange formula that is based on value at risk or VAR methodology. It is structured in such a way that the margin is sufficient to cover 1-day risk.
Margins for selling stocks are needed for risks like unfavourable price movements, delivery shortfalls, bad delivery, procedural faults in delivery etc.
That is entirely dependent on you. Margin buying calls for strict stop losses and profit targets so losses does magnify. It is possible to do margin trading careful, managing risks.