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Ever felt short of money, which resulted in you being unable to trade in the market? Don’t worry; you do not have to miss out on trading opportunities because margin money has you covered! If this concept seems like one you have never come across, this blog is just right for you.
In this blog, find out everything you need to know about what is margin money and its role in helping you trade in the share and the derivative markets.
What Is margin money?
Margin money, also known as margin, is a financial term that refers to the funds you must deposit to open and maintain a position in the financial market using borrowed funds from your broker. This is applicable to trading shares.
In simpler terms, if you want to trade at larger positions than the ones allowed by your capital, you will borrow the balance of money from your broker to buy the security. In this process, there are risks that the broker would be undertaking. This is where the concept of margin money comes into the picture.
Margin money is the amount of funds that you would deposit with your broker to cover the credit risks. In a way, margin money is similar to a downpayment for purchasing financial securities on credit!
When considering the scenario of derivative markets, margin money in derivatives is the money you deposit as security to start a trade. This is a requirement by SEBI.
Margin money primarily consists of two types:
- Initial Margin – This is the amount needed to start a trade.
- Maintenance Margin – The amount required to keep the position active.
Let’s understand these types in detail now.
Margin money and leverage for share trading
This is only applicable for margin for share trading. For margin money in derivatives, we will clear your doubts soon.
If you are wondering why you should go for margin trading against the leverage you obtain on the margin money rather than buying the financial securities at their 100% value. Wait, let’s first clear up this new fancy word “leverage” before we proceed.
Leverage in trading terms refers to that small fraction of the contract value you will put into obtaining the contract. This fraction of the total value is also referred to as the margin. Now, let’s tackle your question with another new concept – the marginal utility of money.
Margin money operates on a concept called the constant marginal utility of money. This concept believes that receiving a small additional amount of money increases an individual’s satisfaction by a constant amount for every additional unit received. In simple terms, every extra rupee brings in a constant level of happiness.
By trading on margin money, you are essentially increasing the purchasing power of your money and have a higher chance of gaining higher returns. Plus, it is way more flexible than loans.
With this newfound clarity, let us now discuss the different types of margins in much more detail.
What is the initial margin and maintenance margin?
Despite sounding similar and confusing, these margins have significant differences between them. Keep reading to bid goodbye to all the confusion storms in your head.
Initial margin
The initial margin is calculated as a percentage of the trade value of the financial security you are purchasing and acts as a security deposit. If the market does not move in your favour, the broker utilises this deposit to cover the personal losses incurred.
In derivative trading, an initial margin is a prerequisite, whether you’re going long or short on futures contracts. However, in the case of options contracts, you only need margin when trading for the long term.
The initial margin is expressed as the sum of the SPAN margin and exposure margin, and it is time to learn two more new concepts.
SPAN is an abbreviation for Standard Portfolio Analysis of Risk, which is software that is responsible for calculating the margin for F&O contracts. This software uses statistical formulas to calculate the margin requirements.
On the other hand, the exposure margin is the extra amount collected over your SPAN margin to cover against adverse price movements in the market. Unlike the SPAN margin, the exposure margin is usually set by your brokers.
Maintenance margin
Maintaining a minimum margin balance is necessary in trading. The maintenance margin is the minimum amount of money you need to keep in your account to sustain your trade position. It is a safety net, ensuring you have enough funds to cover future losses.
The maintenance margin is mostly calculated as a percentage of the initial margin and differs across stock exchanges. In a way, the maintenance margin is similar to margin money for working capital, which is the additional amount that a business should maintain above its regular working capital in case an unforeseen circumstance decides to pay a visit.
Okay, so what happens if you decide that you do not want to deposit the maintenance margin in your account?
The answer is you receive a margin call from your stockbroker asking you to replenish funds in your account. If you do not comply with these requests, your contracts will be automatically sold. Oh, and also, be ready for penalties!
To avoid these serious consequences, it is best to maintain this margin for a seamless trading experience.
Initial margin vs. maintenance margin
To clarify things, here is a comparison table summarising the differences between initial and maintenance margins.
| Feature | Initial margin | Maintenance margin |
| Purpose | Required to open a new position in the market. | Required to maintain your position in the market. |
| Percentage | The initial margin is set by exchanges and brokers. | The maintenance margin is usually a percentage value of the initial margin. |
| Value | Higher compared to the maintenance margin. | Lower compared to the initial margin. |
| Consequence of Absence | Without an initial margin, you will be unable to enter a market position. | Triggers a margin call; if the funds are not deposited, forced liquidation occurs. |
An example to clear all your doubts
If you are overwhelmed with the information you read above and feel a tiny bit lost, this example should help you.
Let’s say you are planning to buy a lot of futures contracts, which have 2500 units, with each one costing Rs. 100 rupees. Here, the total investment value would be Rs. 2,50,000.
If, after all the calculations, the initial margin is 10%, you will have to deposit Rs. 25,000 rupees into your account to open the position.
After you open the position, let’s assume that the maintenance margin is set to be 40% of your initial margin, implying that you must maintain Rs. 10,000 rupees in your account, and failure to do so would invite a margin call.
| Summary of the example | |
| Total trade value | Rs. 2,50,000 |
| Initial margin | Rs. 25,0000 |
| Maintenance margin | Rs. 10,000 |
Conclusion
In conclusion, understanding margin money is essential for anyone venturing into the trading world. From the initial margin required to open a position to the maintenance margin crucial for keeping trades active, all these concepts are important to understand.
Remember to research these concepts as much as possible before you build your trading plans. Now that you are well aware, it is time for you to go and ace as a trader! To learn more, subscribe to StockGrow.
FAQs
Margin money is a financial term that refers to the funds you must deposit to open and maintain a position in the financial market using borrowed funds from your broker. You need to maintain an initial margin and a maintenance margin.
A margin calculator is a tool that is used to calculate the margin on various financial instruments traded in the markets based on various statistical parameters.
If your margin amount is greater than Rs. 1 lakh or if your margin percentage is greater than 10%, a penalty of 1% is levied. However, if both are less than this limit, you will face a penalty of 0.5%.
Firstly, you will pay a penalty as specified above and a 5% penalty is levied if you fail to cover your shortfall for about three consecutive days and after the window period has expired, the contracts are sold automatically.
Yes, if your margin has a negative balance or shortfall, the margin requirements can increase.
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