The stock market offers intraday traders different methods to gain leverage and maximise returns on their investments. Among these methods, margin trading and short selling are commonly utilised by experienced traders to gain an advantage in equity trading. But it could be equally useful for new investors to learn and understand both, especially for intraday trading, knowing margin trading vs short selling will give you mileage.
Let’s start with the definitions, and then we will move onto explaining the difference between margin trading and short selling.
In simple language, margin trading allows you to invest more than the money that you have in your brokerage or trading account with your broker.
It is also called margin funding. Basically, if you have a margin account with a broker, they will allow you to carry out margin trading. It is a legal method to take a bigger position on your trades by paying a fraction of the cost of a lot of stock or other securities. For margin trading, you need to pay a specific amount of money called margin money.
The margin requirement for stocks, futures, options and currencies differ from each other. However, the underlying principles remain the same: you are borrowing money from your broker to leverage your investment and get higher returns.
Let’s discuss with an instance.
Assume that you have a margin trading account with Angel Broking and Rs. 10,000 in your brokerage account. You want to buy 500 shares of Company XYZ which is currently trading at Rs. 90 per share; so the lot will cost you Rs. 45,000. Normally, your broker will not allow you to buy shares worth Rs. 45,000 with only Rs. 10,000 in your account, but with a margin account you can do that.
The margin requirement for the shares is 20%. Therefore, if you are an intraday trader, you can buy 500 shares by paying only Rs. 9,000. However, there is a catch. You have to close or settle this trade at the end of the settlement cycle, which is usually 2 days after the trade takes place.
But you have to pay Rs. 45,000 and you only have Rs. 10,000 in your account, what do you do? Now, you have to place a sell order of the 500 shares to square off your position in T+2 days. In case XYZ share prices increase to Rs. 115, the value of your portfolio will have increased to Rs. 57,500 and you will have earned a profit of Rs. 3,500 in this trade after deducting the margin money you paid to your broker. (Rs. 57,500 – 45,000) – (Rs. 9,000) = Rs. 3,500.
In case the share price of company XYZ comes down or remains the same, you will still have to close your position at the end of the settlement period and pay the margin amount to your broker. In that case, you will suffer a loss.
Next, we will learn what short selling is to get a better understanding of short selling vs margin trading. As mentioned earlier, if you want to be an intraday trader, it’s important for you to know the difference between margin trading and short selling.
Short selling is a method in which you sell shares that you don’t possess using a margin trading account with the hope that you will profit from falling share prices. Even if you don’t have shares of a particular company in your DEMAT account, your broker can allow you to sell them using a margin account.
Short selling can be explained in 5 simple steps:
1. You borrow shares from your broker, and he sells them for you.
2. He credits your brokerage account with the money after selling the shares.
3. As share prices fall down, you ask your broker to buy the shares and close your position.
4. Your broker uses the money in your brokerage account to buy the same shares.
5. The difference in the sale price and purchase price, after deducting the margin money paid to the broker, is your profit.
Both margin trading and short selling involve risks. That is why only pro traders venture into it. But if you want to start, begin with small steps – research, learn, and practice before you start using these advanced methods.