Margin accounts – the essential facts you need to know

Online trading has made it very easy for investors to trade different market instruments – from shares to mutual funds and exchange traded funds to money market instruments. This trade is conducted through your demat account, which you can open through a depository participant – a brokerage firm or a bank. But a demat account is not the only type of online account you can use for your share market trades. You can also open a margin trading account. This account is slightly different from the demat account. Here are some essential facts about margins and margin trading accounts.

What is a margin account?

As mentioned above, you need to open an online account to purchase and sell your shares. When you open this account you can choose between two basic options – you can either opt for a cash account or a margin trading account. Of these, a cash account is one where you pay for the shares and investments purchased by you, while paying a commission to the broker for the transactions conducted on your behalf. However, a margin trading account is slightly different wherein you do not need to make any upfront cash payments for shares purchased by you. Instead, you are only supposed to deposit a given percentage of your transaction whereas the rest of the amount is loaned to you by the brokerage firm. You also need to know about initial and maintenance margins

Initial margin explained

Before you begin online share trading and start your transactions, you need to deposit some money with your broker. This is referred to as initial margin. Paying this initial margin can prove to be rather beneficial in that you can trade in multiples of the initial margin paid. This is known as leverage. Here’s an example to help you understand initial margin better.

Let’s say Mr. Kumar pays an initial margin of 20% or ₹2,000,000. By paying this deposit, he can purchase shares of up to ₹10,000,000, which makes it easy for him to conduct high volume trades. You can get this kind of leverage only with your margin account. Essentially, you can get a high amount loan from your investment broker to finance your investments. The broker in turn borrows the sums from RBI approved Non-banking finance companies.

Maintenance margin and maintenance call

The share market is rather unpredictable. When the share prices fall, your broker may ask you to deposit an additional amount. This prevents the broker from incurring losses and is regarded as margin call. You are typically told the amount of balance you need to maintain in the margin account and when the value of your share market investments begins to approach that minimum amount; you will be asked by your broker to deposit the additional amount to ensure there are sufficient funds in the account. This means you have to adhere to the margin call. Failure to maintain the margin call or deposit the required sums within the time stipulated by your brokerage firm can result in negative consequences. It gives your broker the right to sell your position without giving you any warning, which in turn may result in a fair amount of loss for you.

Final word: There are innumerable uses of margin trading accounts. You can use them for online share trading as well as for trading in derivatives such as options and futures and even commodity trading. But you need to understand the features and benefits of each type of account. Margin accounts are ideal for frequent traders and can prove beneficial for them.

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