what is Margin in trading, its uses, risks associated

Margin is a credit taken from our brokerage house for investment in stock markets by paying a little interest on it. Generally brokerages allow us to buy more stocks than our actual money, the extra money they provided should be returned along with additional interest. Brokerages use your actual money as surety for their credit.

Here is a simple example,
Consider a stock ‘X’ trading at Rs.100/-, if you have RS.10000/- in hand, got 10 stocks. But you are in great hope that stock will gain good profits. Then, how to buy more than 10 stocks with same money. Here margin plays role. Margin amount should be returned along with interest, brokerage will have no involvement over your profits or losses made.

Taking original investment Rs.10000/- as surety, your brokerage will give another Rs.10000/- as margin (amount of margin varies for different brokerages). Pretty!! 20 stocks with only 10000. Brokerages generally give large margin for intraday traders, and should be returned on the same day along with the interest.

If stocks gain profits, you get more than original profits. Unfortunately if end in losses, you get intense losses than original. Interest rate is addition in either of cases.

How it happens is:

-Consider an investor who taken margin, against his Rs.10000/- to buy 20 stocks each of value Rs.1000/-
1.Suppose stock price rises from 1000 to 1200, Rs.200 is profit on each share.
2.Then on 20 stocks, 20*200 = 4000
3.Here Rs.4000/- is profit.
Investor needs to pay back margin amount along with little interest. (Interest rate varies for different brokerages)
If the investor not utilized any margin he will got only 10 stocks and so profit will be only Rs.2000/-

All this is only one side of coin, ‘as like you got more profits if stock gains, also got more losses if stock price falls.

Suppose, if stock reached to Rs.800/-.
Loss without taking margin = Rs.2000/-
Loss with margin = Rs.4000/-
So if you taken margin, now your net balance will be = 10000-4000 = Rs.6000/-

If the stock price goes on decreasing, your net balance will decline at rapid rate, then the brokerage thinks can the investor can able to pay back our margin amount?
If price of stock reaches a threshold decline level, brokerage sells off all your shares (as they fear of there credit amount), deduct their original margin and interest.
At last you remained with penny balance in your account and no holding shares.
Here, margin-less trader is winner, as he had no fear of selling off by brokerage, he stays with his stocks in account and enjoy the recovery of stock if happens.

So, even though margin is a very useful tool, only utilizing it very careful with follow of a risk less strategy will be beneficial. Don’t take so large available margin, as any mis-happen make you to remain with empty balance.

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