Let us take an example.
You are tracking a stock since a few days and you’ve been waiting for it to fall down to a level from where you are sure it will shoot up again. Now on some very lucky day, the stock actually corrects and at the levels which are really attractive. You think it is time to buy the stock now!
But you waited for one day just to confirm that it rises up again. The very next day the markets opened 400+ from previous close and all indicators are showing you uptrend for both, the stock and the market. You think, it is really time to invest a lot of money in the stock!
If one really had lot of money to invest at this moment, he could have only wished for more. Now you want to invest 5 lakhs of rupees, but you have only 1 lakh. Where do you get this money? You can do one thing, borrow. Borrow from bank, family, friend or anyone who can lend you. But it is really getting late, the stock is all set to run off to heights.
There is another thing you can do. Trade on Margin. Trading on margin means, you do make trade of worth more than the money (or the funds) you actually hold in your hands. The margin facility is provided by almost all brokers, at different levels for different investors.
How does it work? For the example above, it works like this. Though you hold a lakh rupees only, but you can make investments worth 5 lakhs. The broker has provided you with a margin of 4 times.
There are other nitty-gritties involved in margin trading related to how it is done, how balances are maintained, what are margin calls, etc. I will take this up in a separate post.
Why would a broker lend at all? There are 2 main reasons. One, the margin facility is not for free. The broker will charge you some interest for using the margin. You should contact your broker to get more information on the rates and margin levels.
The other reason is that the brokers love when you trade. Obviously, they are giving you cash so that you can spend and when you will spend, they will earn the brokerage. It is a simple business.
Should I trade on Margin? Now this is a question which I always love to talk about. I have my own views about trading on margin.
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