A presentation on the basics & fundamentals of Margin Trading. The information has been compiled from various financial websites.

1. MARGIN TRADING

2. WHAT IS MARGIN TRADING?
 Margin trading is buying stocks without having the entire money to do it. The exchanges have an
institutionalised method of buying stocks without having the capital through the futures market.
 A method of buying shares that involves borrowing a part of the sum needed from the broker executing the
transaction. The collateral for the loan is normally securities in the investor's account. The investor must
deposit an initial amount of cash(down payment called “margin”) or securities (initial margin or margin
requirement) into a margin account with the broker & can purchase stocks worth more, and must thereafter
maintain a minimum amount of cash or securities (margin) in the account as collateral (maintenance
margin, minimum maintenance or maintenance requirement).
 The broker charges interest on this loan(in addition to the commission on each buy/sell trade).The investor
has to keep the entire stockholding with the broker as collateral.
 Also, the investor has to put up additional cash in case the value of the stockholding falls below a certain
amount.
 Margin trading is a double-edged sword – it cuts both ways. If the stock price rises, the investor makes twice
as much profit with utilization of half(50%) borrowed funds as with his own cash only. Similarly, if the stock
price falls, the investor loses twice the amount. In slang, this practice is called 'investing on steroids.'

3. POSITION TAKING
Position Taken with 10 % Margin
Trading
Equity Borrowings
Position Taken with Normal Trading
Equity Unutilized Borrowing Capacity

4. LEVERAGE: MAGNIFYING EFFECT OF RETURNS
NORMAL TRADING MARGIN TRADING
PARTICULARS CODE AMOUNT
Purchase Price of Asset A 10000
% Self-financed(10%) B 1000
% Borrowed(90%) C=A-B 9000
Change in Value D 20%
Return(Absolute)
<Assumed>
E=A*D 2000
Rate of Return(Relative)
<Computation>
F=E/B*
100
200%
<=2000/1000*100>
NET VALUE(Asset Value
– Debt)
F=B+E 3000
<Rs.1000+Rs.2000>
PARTICULARS CODE AMOUNT
Purchase Price of Asset A 1000
% Self-financed(100%) B 1000
% Borrowed(0%) C=A-B -
Change in Value D 20%
Return(Absolute)
<Assumed>
E=A*D 200
Rate of Return(Relative)
<Computation>
F=E/B*100 20%
<=200/1000*100>
NET VALUE(Asset Value
– Debt)
F=B+E 1200
<Rs.1000+Rs.200>
It is assumed that the trader has Rs. 1000/- available for investment at the beginning.

5. MARGINAL OUTCOMES
STOCK PRICE RISES ↑ STOCK PRICE FALLS ↓
PARTICULARS CODE AMOUNT
Purchase Price of Asset A 10000
% Self-financed(10%) B 1000
% Borrowed(90%) C=A-B 9000
Change in Value D (-)20%
Return(Absolute)
<Assumed>
E=A*D (-)2000
Rate of Return (Relative)
<Computation>
F=E/B
*100
(-)200%
<=(-)2000/1000*100>
NET VALUE(Asset Value –
Debt)
F=B+E (-)1000
<Rs.1000-Rs.2000>
We know that all the risks are to be borne by the owner & all the returns to are the right of the owner after paying the fixed
costs. Hence, whatever be the effect of the return on the overall investment is to be absorbed solely by the capital
investment by the owner.
PARTICULARS CODE AMOUNT
Purchase Price of Asset A 10000
% Self-financed(10%) B 1000
% Borrowed(90%) C=A-B 9000
Change in Value D 20%
Return(Absolute)
<Assumed>
E=A*D 2000
Rate of Return (Relative)
<Computation>
F=E/B*
100
200%
<=2000/1000*100>
NET VALUE(Asset Value
– Debt)
F=B+E 3000
<Rs.1000+Rs.2000>

6. EXPOSURE: BUYING POWER
 For Example, if you were to buy 2000 shares of say Company A, which trades at Rs.
300, you will need about Rs. 6 lakh. But if you buy a future contract of that
company, which comprises 2000 shares, you only need to pay a margin of 15 per cent. So
by putting Rs. 90,000, you can get an exposure of Rs. 6 lakh.
 The same operation can also be executed through margin trading. Here, the trader will buy
2,000 shares, which are partly funded by the broker, and the rest by the trader.
 The percentage of margin funding may range between 50-90 per cent, depending on the
broker and his relationship with the client. The broker, in turn, funds his line of credit from
a bank, and keeps the shares in his account with any profit/loss going to the client.

7. MARGIN TRADING
VS.
FUTURES TRADING
 Most investors buy the futures, but there are times when margin trading makes mores
sense. If a stock is not in the futures list, the client can go for margin funding.
 Since futures are generally not available beyond one or two months, if the client has a
longer view, then margin trading is better. Also, some brokers offer lower interest rates on
margin trading than the prevalent rates in the futures market.
 Generally, when you deposit a margin on a stock purchase, you buy partial equity of the
stock position and owe the balance as debt. In the futures market, a margin acts as a
security deposit that protects the exchange from default by the customer or the brokerage
house.

8. THE MARGIN CALL: CHRONOLOGY
Once the trader buys a future or stocks in the margin account, the client gets the profit/loss since
his purchase in his account.
In both futures market and margin trading, if the value of the share falls below the purchase
price, the broker will make margin calls, if the net value of his investment goes below the
margin decided, asking the client to deposit additional margin.
In a normal market, these margin calls are not a problem as clients can deposit the additional
amount easily.
When clients are not able to meet the margin requirement, the broker sells the security so that
he does not have to bear the risk in case the stock falls further. This typically become a problem
when the markets fall far more than expected and traders are not liquid enough to meet the
margin calls. And when a lot of traders can't meet margin calls, the situation snowballs.

9. THE MARGIN CALL
 Definition: A broker's demand on an investor using margin to deposit additional money or securities so that the margin account is
brought up to the minimum maintenance margin. Margin calls occur when your account value depresses to a value calculated by the
broker's particular formula.
 Meaning: You would receive a margin call from a broker if one or more of the securities you had bought (with borrowed money)
decreased in value beyond a certain point. You would be forced either to deposit more money in the account or to sell off some of your
assets.
 Once the trader buys a future or stocks in the margin account, the client gets the profit/loss since his purchase in his account.
 In both futures market and margin trading, if the value of the share falls below the purchase price, the broker will make margin calls, if
the net value of his investment goes below the margin decided, asking the client to deposit additional margin.
 Similarly, it could also happen when the margin requirement is raised, either due to increased volatility or due to legislation. In extreme
cases, certain securities may cease to qualify for margin trading; in such a case, the broker will require the trader to either fully fund
their position, or to liquidate it.
 In a normal market, these margin calls are not a problem as clients can deposit the additional amount easily.
 When clients are not able to meet the margin requirement, the broker sells the security so that he does not have to bear the risk in case
the stock falls further. This typically become a problem when the markets fall far more than expected and traders are not liquid enough
to meet the margin calls. And when a lot of traders can't meet margin calls, the situation snowballs.
 Margin requirements are reduced for positions that offset each other. For instance spread traders who have offsetting futures contracts
do not have to deposit collateral both for their short position & their long position.

10. THE MARGIN CALL: EXAMPLE
 Jane buys a share in a company for $100, using $20 of her own money, and $80 borrowed
from her broker. The net value (share - loan) is $20.
 The broker wants a minimum margin requirement of $10.
 Suppose the share goes down to $85. The net value is now only $5 {net value ($20) -
share loss of ($15)} or {$85(Value of underlying asset)-$80(Value of Debt)}, and Jane will
either have to sell the share or repay part of the loan (so that the net value of her position
is again above $10).

11. THE ADVANTAGES
 Increased buying power with less money.
 More profit with less investment.
 A trader can burrow up to half of his purchasing price as initial margin.
 Greatly suitable for day traders, who need to complete more number of trades with higher
volume stocks.
 Suitable for experienced traders, having knowledge of stock market trend patterns.

12. THE RISKS
 If the stock goes nowhere, you still have to pay interest on that margin loan.
 Add more burdens on traders’ shoulders in losing trades.
 Have to payoff interest on margin.
 Cannot trade all stocks - like OTC stocks, penny stocks, IPOs etc.
 Your account balance and buying power changes with changes in stock prices.
 The chance of margin call is always prevailing.
 You are always obligated to keep a minimum account – the maintenance margin.
 With falling stock prices the traders have much less control.
 Not advocated for novice traders.

13. STRATEGIES TO MITIGATE RISK
 You can reduce the risk of trading on margin by:
 Trading contracts that are lower in volatility.
 Using advanced trading techniques such as spreads, or positions in which you simultaneously buy and sell
contracts in two different commodities or the same commodity for two different months, to reduce the risk. An
example of an intramarket spread is buying March crude oil and selling April crude. An example of an intermarket
spread is buying crude oil and selling gasoline.
 Have ample reserves of cash or marginable securities in your account. Try to keep the margin ratio at 40
percent or less to minimize the chance of a margin call.
 If you're a beginner, consider using margin to buy stock in large companies that have a relatively stable
price and pay a good dividend. Some people buy income stocks that have dividend yields that exceed the margin
interest rate, meaning that the stock ends up paying for its own margin loan. Just remember those stop orders.
 Constantly monitor your stocks. If the market turns against you, the result will be especially painful if you use
margin.
 Have a payback plan for your margin debt. Margin loans against your investments mean that you're paying
interest. Your ultimate goal is to make money, and paying interest eats into your profits.

14. THE END