Margin refers to the amount of money borrowed from a broker to purchase an investment. It's essentially a loan from your brokerage firm, and it allows you to buy more shares than you could with just your available funds. This practice is known as buying on margin.
How It Works: When you buy on margin, you're using a combination of your own funds and borrowed funds to make the purchase. For example, if you buy Rupees 10,000 worth of stock and you have Rupees 5,000 of your own, you might use Rupees 5,000 in margin (borrowed money) to cover the rest.
Initial Margin: The percentage of the purchase price that must be covered with your own money when you first buy securities on margin.
Maintenance Margin: The minimum amount of equity that must be maintained in your margin account after the purchase. If your account falls below this level, you'll receive a margin call.
Margin Shortfall
Margin shortfall occurs when the value of the securities in a margin account falls below the maintenance margin requirement. This can happen due to a drop in the market value of the securities or if the initial margin requirement is increased. Penalties are levied on margin shortfall
Margin Call: If a margin shortfall occurs, the brokerage will issue a margin call, demanding that you deposit more funds or securities into your account to meet the minimum equity requirement. This is to ensure that the amount borrowed doesn't exceed the agreed percentage of the total investment value.
Risks: If you cannot meet the margin call, the brokerage has the right to sell your securities, often at an unfavorable market price, to cover the shortfall. This can result in significant financial loss.
Leverage Effect: Trading on margin amplifies both gains and losses. While it can increase potential returns, it also increases potential losses, including the possibility of losing more than your original investment.
In summary, margin trading allows investors to leverage their investments but comes with higher risks, including the possibility of a margin shortfall and subsequent margin calls. It's essential for investors to understand these risks and carefully manage their margin accounts to avoid such situations.