Buying equity with own money versus margin money
Assume a hypothetical situation where you want to buy 500 shares of TCS at the current market price of Rs3,344. It would approximately cost you about Rs16.72 lakhs. If you have that kind of funds with you, you can directly buy the stocks in the equity market through your trading account. Of course, it would still depend on you whether you are looking at as an equity investment or for equity trading. Typically equity trading involves buying and holding for a shorter period of time like say a few weeks or a couple of months or can even be as short as a few days. On the other hand, equity investment is more about a long term decision to hold on to the stock in the hope of wealth creation.
The above situation is assuming that you have the funds to buy 500 shares of TCS. What if you don’t have the funds? You can still buy these stocks using the equity margin account with your broker. In this trading account, you put in a certain amount of equity margin to the tune of 15-20% and the broker funds the rest of the amount. This allows you to purchase more shares than you can afford with own funds and ensures you don’t miss out on opportunities. However, margin trading has two more implications. It also includes margins paid for intraday trading which you can figure out through the margin equity calculation. This can also refer to equity futures margin, which is the margin (as a percentage of transaction value) you have to pay to take a long / short positions in the futures market.
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How the risks and returns of equity margin trading differs?
One of the big advantages of equity margin trading is that you can actually tap opportunities which you cannot afford with your own funds. An equity margin account is a loan by the broker to buy the shares and normally the shares have to be pledged to the broker. The initial margin (for skin in the game) can either be paid in cash or by pledging stock value or your portfolio. On the borrowed amount, there is interest payable, but that is at quite a reasonable rate due to being back-to-back secured funding. Since you only put a margin of 20% to 30% for the position, your return on investment (ROI) can get magnified.
However, equity margin trading is not roses all the way. The longer you hold the position, the more interest you have to pay; normally allowed up to 1 year. Also, just as profits get magnified in a equity margin position, the losses can also get magnified if the stock moves the other way. That is why, in equity margin funding, you prefer companies that have value and momentum in their favour. Another risk in margin funding is that if the margins are not sufficient then you either have to bring in cash or put more stocks, failing which positions can be cut by the broker to keep portfolio losses under check.
Understanding margins on intraday trading and futures trading
While we normally understand margin trading as taking a loan and investing in stocks, it also has other implications, although the concept remains the same. Margins are about leverage, i.e. allowing the trader / investor to take a larger position than they can afford with their own funds. Here is what it can imply.
- To take any position in the stock market, an initial margin has to be paid, which is a reassurance to the exchange that the trader will honour their side of the contract. It also acts as a commitment money. In the case of delivery, investors can take a position by paying margins on trade day and pay the full amount by next day.
- The second type of margin is intraday margin, where the trader has to pay upfront the VAR (value at risk) margin and the extreme loss margin (ELM) to take such positions. However, such intraday identified positions have to be closed on the same day, failing which the broker will close positions by 3.15 pm.
- The third is margin on futures positions, which is based on SPAN margins and ELM and are defined by the exchange for all the F&O eligible stocks and indices. These margins are necessary for long futures, short futures and for selling options. However, for buying options, only premium margins have to be paid.
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