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Understanding Margin Trading Accounts

Definition and Meaning

The process of margin trading can be defined as “margin trading refers to the process whereby individual investors buy more stocks than they can afford to. Margin trading also refers to intraday trading in India, and various stockbrokers provide this service.” In simple words, brokers provide you with more money than you have in your bank account for trading purposes and in return they do not ask for the profits which you have earned using their money. However, we need to keep in mind that margins are generally not available for upcoming IPOs as they are quite risky. Having understood this, let us look at some common terms related to margin trading and their definitions:

Margin account: 

It is an account opened with the broker where the funds available for you to take as margin are kept. It is compulsory to open a margin account before you can start trading using margins. 

Margin equity

It is the cash amount present in your margin account. 

Minimum margin: 

Minimum cash amount which should be deposited while opening a margin account and which should be present in the account before trading.

Initial margin

Minimum cash amount which should be present in the margin account before you can make a particular trade, in addition to the minimum margin.

Square off

Selling of shares. 

Margin call

Call from the broker to maintain your minimum margin balance in case it goes down below that level.

How to open a Margin account

The process of opening a margin account is quite similar to opening a trading account, except that here you have to deposit a minimum margin amount at the time of opening. To open a margin account: 

  1. Fill out the form for opening a new margin account with your desired broker.
  2. Submit the required documents (PAN card, Aadhar card, Identity proof, etc.).
  3. Get the verification of documents done.
  4. Go through the in-person KYC or eKYC depending upon your broker.
  5. Sign an agreement and the POA (Power of Attorney) to sell your shares on your behalf.
  6. Deposit the minimum margin amount as requested by your broker.
  7. Receive the credentials related to your margin account and start trading.

How does margin account work?

Now that you have understood the basics of a margin account and how to open it, it is time to learn how it works. Suppose your account has a minimum margin of Rs. 100,000, you want to make a trade of Rs. 250,000 to buy shares of ABC company, and your broker asks you to keep an initial margin of Rs. 25,000 in your margin account for this trade. So your required minimum margin for this trade becomes Rs. 125,000. You placed an intraday order to buy the shares, and you have successfully bought the shares. Let us take different scenarios to understand this properly –

  1. Profit: Suppose company ABC’s share price increases by 10%, and you square off your position. In this case, your profit will be of Rs. 25000 (excluding charges) on an initial investment of Rs. 25,000 of your money. So the ROI becomes 100%.
  2. Loss: Suppose, company ABC’s share fell by 5%, and you booked a loss of Rs. 12,500 on an investment of Rs. Rs. 25,000. Now, the ROI becomes -50%.
  3. Loss and Margin call: Suppose that company ABC’s share price fell by 15%, and you book your loss of 37,500 on the traded value. In this case, your margin equity will become less than the required minimum margin in the account and there will be a margin call from your broker. If you fail to maintain the balance before the specified time, the broker has all the rights to square off your existing positions on the current market price to recover his loss.

Also read:- How To Access Your Demat Account Online?

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