The government has been planning to bring down the future volume in the market and they are doing so by reducing the margin.
What Is Margin?
Margin is the money borrowed from a brokerage firm to purchase an investment. It is the difference between the total value of securities held in an investor's account and the loan amount from the broker. Buying on margin is the act of borrowing money to buy securities. The practice includes buying an asset where the buyer pays only a percentage of the asset's value and borrows the rest from the bank or broker. The broker acts as a lender and the securities in the investor's account act as collateral.
In a general business context, the margin is the difference between a product or service's selling price and the cost of production, or the ratio of profit to revenue. Margin can also refer to the portion of the interest rate on an adjustable-rate mortgage added to the adjustment-index rate.
Margin refers to the amount of equity an investor has in their brokerage account. "To margin" or "to buy on margin" means to use money borrowed from a broker to purchase securities. You must have a margin account to do so, rather than a standard brokerage account. A margin account is a brokerage account in which the broker lends the investor money to buy more securities than what they could otherwise buy with the balance in their account.
Using margin to purchase securities is effectively like using the current cash or securities already in your account as collateral for a loan. The collateralized loan comes with a periodic interest rate that must be paid. The investor is using borrowed money, or leverage, and therefore both the losses and gains will be magnified as a result. Margin investing can be advantageous in cases where the investor anticipates earning a higher rate of return on the investment than what he is paying in interest on the loan.
In the stock market, margin trading refers to the process whereby individual investors buy more stocks than they can afford to. Margin trading also refers to intraday trading in India and various stock brokers provide this service. Margin trading involves buying and selling of securities in one single session. Over time, various brokerages have relaxed the approach on time duration. The process requires an investor to speculate or guess the stock movement in a particular session. Margin trading is an easy way of making a fast buck. With the advent of electronic stock exchanges, the once specialised field is now accessible to even small traders.
The process is fairly simple. A margin account provides you the resources to buy more quantities of a stock than you can afford at any point of time. For this purpose, the broker would lend the money to buy shares and keep them as collateral.
In order to trade with a margin account, you are first required to place a request with your broker to open a margin account. This requires you to pay a certain amount of money upfront to the broker in cash, which is called the minimum margin. This would help the broker recover some money by squaring off, should the trader lose the bet and fail to recuperate the money.
Once the account is open, you are required to pay an initial margin (IM), which is a certain percentage of the total traded value pre-determined by the broker. Before you start trading, you need to remember three important steps. First, you need to maintain the minimum margin (MM) through the session, because on a very volatile day, the stock price can fall more than one had anticipated.
For example, if a Tata Steel stock priced at Rs 400 falls 4.25 per cent and the IM and MM are 8 per cent and 4 per cent of the total value of the shares bought, respectively, then the trade-off 8%-4.25%=3.75% will be less than the MM. In this case, you will either have to give more money to the broker to maintain the margin or the trade will get squared off automatically by the broker.
Secondly, you need to square off your position at the end of every trading session. If you have bought shares, you have to sell them. And if you have sold shares, you will have to buy them at the end of the session.
Thirdly, convert it into a delivery order after trade, in which case you will have to keep the cash ready to buy all the shares you had bought during the session and to pay the broker’s fees and additional charges.
If even one of these steps is missed, the broker will automatically square off the position in the market.
Types of margins
There are different types of margins used. VaR (value at risk) margin covers the biggest loss that can be seen on 99 per cent of days. On liquid stocks, margin covers one-day losses and for illiquid stocks, the margin covers three-day losses. Another type of margin that you may have encountered is ELM or extreme loss margin which is intended to cover extended losses beyond the 99 per cent risk of VaR margin. SPAN is the initial margin that a trader pays to cover 99 per cent value at risk on a one-day time frame. The SPAN margin is used in F&OS. Exposure margin is another F&O margin type where contracts of not just securities but indices are also covered. Exposure margin is an additional margin collected over and above SPAN margin.
Peak margin and new SEBI norms
The adoption of the new norms will be done in phases of three months and the complete adoption will be by September 1, 2021.
In Phase 1 (Dec-Feb), the client would need to have 25 per cent of the peak margin available with the broker. In the next phase (Mar-May), the peak margin that needs to be available with the broker is 50 per cent while in the third phase (Jun-Aug), the client needs to have 75 per cent peak margin. By September 2021, clients need to have 100 per cent peak margins. Penalty for margin shortfall or non-collection is in the range of 0.5 and 1 per cent, depending on the short collection. If there’s a shortfall or non-collection of margins for over three consecutive days or over five days per month, the penalty can go up to 5 per cent.
Till December 1 2020, brokerages were free to offer intraday leverage of any amounts. From December 1, the maximum leverage that can be provided intraday has been stipulated. From September 1, 2021, there will be no additional margins apart from VAR+ELM (equity) and Span + Exposure (F&O). But because each stock has a different VAR + ELM, SEBI has proposed that a minimum of VAR+ELM or 20 per cent of trade value would need to be collected upfront (intraday trades included). Most stocks have over 20 per cent VAR and ELM, so this norm means the maximum intraday leverage for stocks is 20 per cent of trade value.
Also, if you are a trader who sells stocks from your Demat or T1 (buy today sell tomorrow), you have access to only 80 per cent credit against the value of sale for any future trades on the day of selling. Before December 1, 2020, traders got 100 per cent credit.
What the new system entails
While the new peak margin rules have been brought in to correct the situation of excess leverage and bring down speculative trading and protect traders, there is also fear that this will lower intraday trading volumes and market liquidity. When there is greater leverage and a high level of trading activity, market liquidity is naturally higher. But because full margin will be needed by September 2021, experts feel that turnover may be affected. According to news reports, the new SEBI norms had a “moderate” impact on December 2020 turnover. Reports say that the NSE retail cash/overall cash average daily turnover dropped 2.5 per cent/10 per cent month on month while NSE retail/overall derivatives turnover changed minus 6.5 per cent/ plus 3 per cent MoM.
However, the trends need to be watched through the subsequent months before it shows the real impact or not on volumes. Other factors such as the sustained bull run in the markets, inflow of FIIs may offset the fear of low volumes and continue to boost investor confidence.
On another positive note, the opinion is that although volumes may be affected over the short term, the greater transparency brought in by new norms would bring in trust and enhance investor confidence in the system. Thanks to the ceiling on leverage vis-a-vis margins, SEBI has created a uniform and equitable system for brokers. The SEBI norms may bring short-term pains but long-term rewards by making the stock markets, brokerages and trading an efficient and fair system.
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