What is the difference between Margin and Leverage

Your hungry stomach is craving for the delicious biryani in the nearby outlet. But you’re empty-pocket! A friend lends you money for the meal. How’d you feel?

Undoubtedly you’ll be on cloud nine. That person is like an angel in disguise, isn’t it? There may be times when you may see a low-hanging fruit in front of you but may not have the resources to pursue it. That’s where it becomes critical to have someone help you avail these opportunities, in spite of limited funds at hand!

And the stock markets are no different from real life. So the goodies we get in real life apply to it as well. And these kinds of opportunities, in market parlance, are termed as Margins and Leverage.

Margin and Leverage - explained

Say you got an intuition that the stocks of XYZ will be increasing steadily for the next 3 days, or you have information that will fetch you good gains. You have run a number of analytics and found out the same to be true. Unfortunately, you do not have sufficient funds to back your transaction. That is exactly where Margins or Leverage come into play.

So what are these, and how will they help you in building up your income through stock markets is what we’ll be venturing into today. Are you ready?

Margin

What do you do when you want to take a loan from the bank? You will approach the banker with the collateral and request him to sanction a loan. On similar lines, the Margin is where you place your assets as collateral with your broker and request a loan. You will be using this loan amount to carry on your trading activities.

When you intend to operate on Margin, you are required to open a margin account by paying a specified sum as collateral. This sum is otherwise known as minimum Margin. The sum in your account should not fall beyond the set limit.

If it does, then you will be forced to make a margin call. This is where the broker will offer you three options wherein you can either deposit more money, liquidate the investments or pay back the loans using the funds in the account. Here's one recent incident where liquidation of investment was done to partly meet the margin calls:

In Margin, the individual will be required to pay only a portion of the amount needed to open a position, and the rest will be paid by the broker. 

Let us look at the same with an example. Say you are going to buy shares worth 20,000. But you don't have sufficient funds to finance the same. In such a case, you will be paying 10% (assumed value) of 20,000, which is 2000. While your broker, on the other hand, pays the rest. This is termed as the Initial Margin. 

Leverage 

While Margin enables an individual to open an equity account or position, leverage, on the other hand, helps you to increase your purchasing power. It involves the use of different tactics and techniques ultimately focused upon fetching better returns.

Say you want to buy the shares of ABC Ltd, currently trading at around Rs 200. Instead of fully paying the amount, one can simply use the leverage. Then the individual investor will be paying only a part of the amount, say Rs 50. The broker will be paying the rest. Thus, an increase in price by Rs 100 will bring a gain of Rs 250. On the other hand, if you had paid the entire amount, the gain would have been Rs 50 only.

Note that the fall in price will also replicate similar numbers in your loss column. And thus, higher leverage naturally brings in higher risk.

Margin vs Leverage 

In short, Margin lays the road for undertaking the task of leverage in a market. The rates are usually fixed by the respective brokerage firms for both Margin and leverage. However, some notable differences among them include. 

• Margin is usually expressed in terms of the percentage of deposit required, while leverage is denoted through a ratio. For instance -

• Secondly, Margin is usually associated with futures and options. But leverage is the word used when speaking about CFD (Contract for Difference) or spread betting. 
• Also though both are interrelated, one should realise that Margin enables one to leverage, but leverage may involve different tactics, which might not involve a margin account.

SEBI rules on Margin and leverage 

The following are some of the rules that SEBI has laid forward in the recent past with respect to trading in Margin and leverage:

• Initially, the traders were required to maintain the directed margins at the end of the day. But SEBI laid new rules wherein 4 random snapshots will be taken in order to assess if the Margin was maintained. That is, failure to hold minimum Margin on intraday positions will attract a penalty. 
• The maximum leverage a broker can offer is restricted as follows, 

Maximum leverage = VAR + ELM (min 20% ) or SPAN + Exposure

where, VAR - Value at Risk and ELM - Extreme loss Margin

• If you are someone looking for margin funding, then you will have to pay about 30% upfront.

Are Margin and Leverage meant for you? 

Leverage allows you to utilise the full power of your capital. You will be exposed to different securities. As a result, you will be able to gain more, and the profits are mostly multiplied by many times. When you get so much, there should be a trap to catch you, right? The risk you assume is that losses might bring an obligation to pay a huge amount to your broker.

Second of all, if your portfolio does not require such a step, then it is better to stay away. If your financial goals are aligning with your intention to operate on Margin, then it is a good idea to go. However, irrespective of the circumstance, one should never lose sight of the risk associated with the same.

Remember this line of wisdom that we'd quoted in one of our previous articles -

To sum up

In short, it is an act of effective manipulation that might turn tables when trading in Margin. There have been instances where leverage and margins probed to be detrimental to investment goals. Hence, it's better not to spend money that you don't own, unless, of course, either it deems necessary or you can absolutely nail that trade.

Further, if you are a newbie, it might not be a sound option for you to immediately jump into margin trading and leveraging. So, assess the market and get well equipped with the right knowledge and info before looking to make an entry.

Anyway, are you into margin trading and leveraging? Whether yes or not, what prompted you? Let us know in the comments below