Introduction:

When applying for a high-value loan, banks often want some assurance in case you cannot repay it. This assurance is called collateral. Collateral can take various forms, ranging from shares and real estate properties to other valuable financial assets. Banks commonly request collateral to mitigate their risk and ensure they can recover the loan amount if the borrower defaults. This idea is similar to what brokers do with margin money. Find out more margin money and how to use it when trading in the stock market.

What is margin money?

As an investor, you might need more funds than you currently have to invest in some securities. In such a case, you have the option to borrow money from your broker. Margin money is a type of collateral or deposit that you submit to the broker. This deposit covers the risk associated with the securities you invest in.

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The broker lends you the rest of the money to cover the value of the investment. In the unfortunate case where the assets do not perform as well as expected and there is a loss, the broker has the authority to sell off these securities without your permission. When they do sell, the money they get goes straight to paying off the debt you owe. If any money is left after settling the debt, it is yours to keep. However, you might not get anything back if the debt eats up all the proceeds.

Margin money can be used for various securities, such as:

• When you opt to buy stocks

• For intraday trading, while taking a long or short position

• When investing in the futures market - buying or selling

• When dealing with options, especially for selling options

Example

Let's consider a scenario where you deposit Rs 5,000 into your margin account. With a 50% initial margin requirement, you can borrow up to Rs 5,000 from the account. Suppose you decide to buy stocks with a value of Rs 2,500. Since you have only utilised half of your buying power, you still have Rs 2,500 remaining in your account that you can use for additional investments without dipping into your borrowed funds.

Once you decide to purchase securities worth Rs 5,000 or more, your initial deposit has been fully utilised, and any further transactions would involve borrowing money from your margin account.

Understanding margin terms

Certain terms play a pivotal role in determining your investment when engaging in margin trading. Here is a breakdown of some key terms:

1. Minimum margin: The minimum margin is the initial investment that a broker may require from you as an investor. This amount indicates your commitment to the trade. It also acts as a safety net for both you and the broker.

2. Initial margin: When you enter into a margin trade, the initial margin is the specific sum you, as an investor, need to contribute.

3. Maintenance margin: Maintaining a minimum balance in your account becomes crucial as the trade progresses. This minimum, known as the maintenance margin, is essential to retain your position in the margin trade.

4. Margin call: Margin call is a signal from the broker that you need to either deposit more funds into your account or adjust your position. This happens when you engage in margin trading, and unfortunately, your account balance dips below the maintenance margin. If you fail to meet this call, the broker has the authority to sell off your securities to recover the lent cash.

Things to keep in mind when using margin money

• One of the primary advantages of margin trading is the potential for greater gains through leverage. However, while leverage can amplify gains, it works the same way in magnifying losses. The broker has the authority to sell the investor's securities to recover borrowed funds.

• Unlike traditional loans with fixed Equated Monthly Installments (EMIs), margin loans may not have a strict repayment schedule. However, margin trading often comes with additional costs, including account fees and interest charges on the borrowed funds. These fees can erode profits and add to the overall expense of the investment.

• Margin trading enables you to purchase more securities than you could afford with your own capital alone. However, if the account balance falls below the maintenance margin, you may be required to deposit additional funds promptly.

To sum it up

Margin money has a lot of benefits. The primary one is that it lets you participate in the stock market even if your own funds are a bit tight. But remember, it is not without its risks, and it is crucial to be aware of the potential ups and downs.

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