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What Is Margin Money and How It Works?

17 Jul 2023

Introduction

The margin is the collateral deposited to the broker by an investor as a guarantee for loan repayment. In case of a default, the collateral in the form of margin money will be seized by the broker. The purpose is to cover the risk of financial loss for the broker.

How does margin money work? 

An investor purchases stocks on margin by taking out a broker loan. This loan covers the extra amount which is still to be paid by the investor. In some cases, there is an interest associated with this loan.

Why does this situation arise?

Let’s say an investor borrows money from a broker. The investor purchases some financial assets from these funds. However, these assets suffer a loss. The investor now has to submit collateral to the broker in the form of personal securities. The broker can liquidate these securities without the permission of the investor. When this happens, the money realized goes towards clearing the debt. The investor would receive the remaining funds (if any) after settling all dues.

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What is the purpose of margin money?

Margin money serves two main purposes – 

  1. Risk management and debt reduction: Brokers who ask for a margin ensure the investor has an ownership stake in the deal. Following this, the risk of loss is lower.
  2. Prevents any ill practices: It also serves as a means for preventing over-borrowing and possible market manipulation.

What are the crucial aspects of margin money?

Here are some useful insights to cover the intricacies of margin money -

  1. The minimum margin is what a broker may demand an investor to provide as an initial investment.  
  2. The initial margin is the sum an investor must contribute towards a margin trade. 
  3. The maintenance margin is the minimum balance in the account that needs to be maintained. This ensures the investor a position in a margin trade.  
  4. A margin call is when an investor fails to maintain the minimum account balance. In order to recover the lent cash, the broker liquidates the investor's securities.

Is using margin money a smart move?

Here are some key aspects related to using margin money to help you make an informed decision: 

1. Margin money is profitable when an investor makes a lot of money on their investment. But this profit needs to be more than the loan. 

Example – You want to invest in stocks and decide to purchase 200 shares of an organization at Rs. 100 per share. However, you just have Rs. 10,000 with you. You then contact a margin broker for money. Your broker gives you the remaining amount, i.e., Rs. 10,000. With this, you can access shares worth Rs. 20,000 (Rs.200*100). The stock market witnesses a positive fluctuation as the organization’s share value increases. The price increases to Rs. 150 per share, now standing at Rs. 30,000. Paying back Rs. 10,000 to the broker, you have a margin profit of Rs. 10,000. 

2. Margin money results in a loss when an investor loses money on their investment. This loss gets even worse with the added loan. 

Example – You want to invest in stocks and decide to purchase 500 shares of an organization at Rs. 200 per share. But you only have Rs. 30,000 available in your account. You then contact a margin broker for financial support. Your broker agrees to support you with Rs. 70,000. Now you can access shares of Rs. 1,00,000 (Rs.200*500 shares). The stock market witnesses a negative fluctuation as the organization’s share value declines. The price falls down to Rs. 150 per share, resulting in just Rs. 75,000 of the total sale value. Paying back Rs. 70,000 to the broker, you have a margin loss of Rs. 25,000.  You may use margin calculator to calculate your Margins.

Conclusion

As an investor, it is important to learn about the various aspects of margin money. It helps safeguard your investments, maintain required collateral levels, and effectively manage investment risks.

Related Articles: Using futures as a form of Margin Trading in Stocks | How to Place a Margin Trade On the MO Trader App | The importance of operating margins for a company

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