What are the Risks Associated With Margin Funding?
Day traders are the lifeblood of the market. Their daily trading activities are the reason why the stock market stays in motion at all times. The erratic ups and downs of the market are a result of intraday traders who commonly use margin trading to finance trade positions that are created and squared off at any given time before the end of the day.
Trading done through margin funding does not require the trader to pay the full amount of the share’s price to their broker, only the margin amount will do. The margin percentage depends on the volatility of the stock in question and can range anywhere between four to sixty percent. The brokerage considers the value at risk or VaR of the stock and adds it to the risk-specified mark up to calculate the margin value of the stock.
Brokerage rates apply to margin funding trades, but they vary from trader to trader. Highly active day traders pay as low as 0.02% on the first leg of the trade, whereas conservative traders may be charged as much as 0.05% to 0.1%. The rates you pay depend on your daily trading volumes. You can avail for this facility at most trading sites.
Rewards Vs Risks when trading through margin funding
Let’s take the example of intraday trader Amyn Lakdawala. Amyn is a seasoned trader who knows the risk-to-reward ratio of trading using margin funding. He knows that if he wishes to go long (buy) or short-sell on, for instance – 100 L&T shares at its current market rate of INR 2,500 per share, his total investment value comes to INR 2.50 lakh. Thankfully, all he has to pay is the margin value of the shares and his brokerage will cover the rest. The margin requirement set by his brokerage is 15 per cent, and Amyn need only pay INR 37,500 (2,50,000×15/100=37,500) to go long or short-sell 100 L&T shares.
The Reward Scenario
If Amyn decides to go long and is rewarded with a favorable rise in L&T’s market share value to say INR 2,520 during the day, he can square off the trade, booking an easy profit of INR 2,000. The gross profit value of his trade is now INR 2,000 on an investment of only INR 37,500 making Amyn’s gross returns on that trade a good 8.89% in a single day!
If the market fluctuates on L&T’s share value to INR 2,480, then Amyn incurs a loss of INR 2,000 instead, thereby making his return value fall to a negative 8.89% on his investment of INR 37,500. Amyn will have not only incur a loss but now he will have to make up for the reduced margin if his broker calls him on it.
Had Amyn decided to short-sell on L&T, then the opposite of the abovementioned scenario would come true, that is, where if the share price goes above the INR 2,500 mark, then he incurs a loss; whereas, if the share price goes below INR 2500, he books a profit.
Trading with margin funding may prove to be too tricky for beginners. Thankfully, experts at Prabhudas Lilladher are trained to assist you with margin trading as required. Simply refer to our website to learn how: PL India