To initiate a trade and execute a transaction through margin funding, you will – most importantly – require a margin trading account. You can open one with any brokerage by either investing your own cash or offering securities available in your demat account. Margin funding can be availed from both brokers and bankers, however most investors prefer trading using margin funding facility provided by brokerages.
Even though you may have opened a margin trading account using cash, your brokerage will consider any stock purchased through margin funding as collateral securities. There are two types of margin requirements that you need to consider when trading through margin accounts, the initial margin and the maintenance margin.
Initial margin is, quite simply, the minimum equity amount that the investor must provide for the stock when they wish to purchase it. It is measure levied on investors against overtrading and excessive speculation. It is also the margin in question when investors discuss trading through margin funding. All marginable securities have their own specific initial requirements and are subject to change, should the authorities deem to do so from time to time.
Investors can avail margin funding as long as their margin accounts adhere to a level equal to or greater than the value of the pre-determined initial requirement of their securities. Keeping that in mind, investors are free to use their margin trading accounts as they see fit. However, if the value of the trader’s investments decline below initial margin requirement, they are bound to incur a drop in their margin value.
When the equity falls short of the initial margin requirement, the investor’s account is restricted from purchasing any further stock through margin funding. While you need not add any more equity or cash, you are still required to raise the level of margin back to its initial value through the funds generated from selling your securities, to uplift the account restriction.
Maintenance margin is the other margin requirement that is imperative for investors to fulfill. It is the absolute minimum equity amount, also called the margin amount that you must maintain in your margin account to continue trading with margin funding. In an event where the margin falls below this margin requirement, your brokerage either makes a margin call or liquidates your collateral securities to maintain the minimum margin requirement as mentioned in the contract at the time of purchase.
If you incur a loss on the market and the value falls below the minimum maintenance margin, then the brokerage calls you to make up for the loss equivalent of the maintenance margin through cash investment or asks you to liquidate your positions. This can be considered a warning call where you may choose to remedy the situation through either of the options within a short time window. Failure to do so will leave your broker with no other choice but to sell some of your collateral securities on the market, the returns of which will be used to bring back the level of maintenance margin required, while the access of those returns are credited to your account.
This is a very useful aspect of margin funding as it protects not only the brokerage but also the investor, where the brokerage need not absorb any unnecessarily excessive losses from the investor – who in-turn is kept safe from being completely wiped out.