Margin buying

Examples
Jane buys a share in a company for $100, using
$20 of her own money, and $80 borrowed from
her broker. The net value (share - loan) is $20.
The broker wants a minimum margin
requirement of $10.

Suppose the share goes down to $85. The net

value is now only $5 (net value ($20) - share
loss of ($15)), and Jane will either have to sell
the share or repay part of the loan (so that the net
value of her position is again above $10).

Margin buying is buying securities with cash borrowed from a broker, using other
securities as collateral. This has the effect of magnifying any profit or loss made on the
securities. The securities serve as collateral for the loan. The net value, i.e. the difference
between the value of the securities and the loan, is initially equal to the amount of one's
own cash used. This difference has to stay above a minimum margin requirement, the
purpose of which is to protect the broker against a fall in the value of the securities to the
point that the investor can no longer cover the loan.

In the 1920s, margin requirements were loose. In other words, brokers required investors
to put in very little of their own money. Whereas today, the Federal Reserve's margin
requirement limits debt to 50 percent, during the 1920s leverage rates of up to 90 percent
debt were not uncommon.[1] When the stock market started to contract, many individuals
received margin calls. They had to deliver more money to their brokers or their shares
would be sold. Since many individuals did not have the equity to cover their margin
positions, their shares were sold, causing further market declines and further margin calls.
This was one of the major contributing factors which led to the Stock Market Crash of
1929, which in turn contributed to the Great Depression [1], a troubling financial time in
the 1930s. However, as reported in Peter Rappoport and Eugene N. White's 1994 paper
Was the Crash of 1929 Expected[2], all sources indicate that beginning in either late 1928
or early 1929, "margin requirements began to rise to historic new levels. The typical peak
rates on brokers' loans were 40-50 percent. Brokerage houses followed suit and
demanded higher margin from investors."
Learn Forex Trading » Trading on Margin

Trading on Margin
What is Margin?

Margin investing is a borrowing method by which a forex investor can trade currencies at
higher volume than he would be able to on his own. The intuition is simple: A forex
investor sees an opportunity in the currency market that no one else does and wants to
capitalize on this information. Ordinarily he would only be able to trade the money that
he has in his forex account; however, if he is particularly confident that his investment
will yield big returns based on shifting exchange rates, then he might want to borrow the
extra money from hisforex broker.

By definition, trading on the margin for a particular currency trade is the equity
percentage the trader must have (in the originating currency) with his broker in order to
make a currency exchange.

Margin Trading Example

Let's give an example. Suppose the trader has USD 5,000 in his account and has a margin
capacity of 5%. The margin capacity reflects the minimum equity percentage that the
trader is allowed to maintain. This means that the trader is allowed to trade a maximum
of USD 100,000 in foreign currency by borrowing the remaining USD 95,000 from his
broker.

Phrased differently, the 5% capacity means that the trader can trade at up to twenty times
the value of his portfolio. The borrowed money required to reach the trading limit is
usually interest-free short-term credit, and the total trading transaction is used as
collateral for the loan.

It is clear that trading on the margin is only for the most risk-loving investors. While the
loans that most brokers give are interest-free on short-term horizons, a forex trader can
easily fall into heavy debt if the currency he trades into devalues.

Let's return to the previous example, and suppose that the trader decides to buy JPY.
Suppose further that he buys USD 100,000 worth of JPY at an exchange rate of JPY
100/USD 1. This would put him at JPY 10,000,000. Consider a situation where the
broker's loan horizon is one month and economic turmoil in Japan leads to a devaluation
of the JPY over the ensuing month, leading to an exchange rate of JPY 150/USD 1. The
investor now must pay back the USD 95,000 that he originally owed, but the value of his
holdings in USD is only USD 66,666.67. So he is in debt by an amount of USD
28,333.33.
Clearly, there is also the opportunity to make a lot of money through margin trading if
interest rates tip in one's favor. The basic idea is that trading on the margin allows one to
magnify one's possible gains and losses by borrowing the extra equity required.

Taking Advantage of Higher Margin

Having finished some of the basics, the reader might now be wondering how what we've
been talking about differs from margin trading in the stock market. There are some
differences in the types of margin trading in the two markets. The main difference is that
brokers normally only allow investors to trade at up to two times the value of their
accounts (i.e., traders are only allowed to trade at as low as 50% capacity). There are also
maintenance margin requirements in stock trading. That is to say that if the investor's
stock value at any point devalues to the point where the investor's equity plummets below
30%, the broker immediately demands payment from the broker. This maintenance
margin in enforced in part to protect both parties from a situation where the trader
accumulates more debt than is manageable.

Clearly while margin trading (in any market) has potential for great gains, it does not
come without increased risk. This form of investing is only for the seasoned, risk-loving
trader. One might add as a side note margin trading canbecome a gigantic problem for the
market as a whole, not just the individual debtor, when whole swathes of people default
on their creditors. Looking back to the prototypical example, the defaulting of a bevy of
margin traders in the 1920s led to a widespread selling epidemic in U.S.stock markets,
ultimately spurring the Great Depression.

Over The Counter Exchange of India(OTCEI) was incorporated in October 1990

under Section 25 of the Companies Act, 1956 with the objective of setting up a national,
ringless, screen-based, automated stock exchange. It is recognised as a stock exchange
under Section 4 of the Securities Contracts (Regulations) Act, 1956. It was set up to
provide investors with a convenient, efficient and transparent platform for dealing in
shares and stocks; and to help enterprising promoters set up new projects or expand. their
activities, by providing them an opportunity to raise capital from the capital market in a
cost-effective manner. Trading in securities takes place through OTCEI’s network of
members and dealers spanning the length and breadth of India. OTCEI was promoted by
a consortium of financial institutions including :

• Unit Trust of India.

 • Industrial Credit and Investment Corporation of India.
• Industrial Development Bank of India.
• Industrial Finance Corporation of India.
• Life Insurance Corporation of India.
• General Insurance Corporation and its subsidiaries.
• SBI Capital Markets Limited.
• Canbank Financial Services Ltd.

Trading on OTCEI:

Trading on OTCEI is the first of its kind in India. It is fully computerised set-up where
trading takes place through a network of computers at the member/dealer end which in
turn are connected to a central computer at OTCEI, Mumbai.

• Initial Allotment: The tradable document on OTCEI is the Initial/Permanent

Counter receipt. The investor who has been allotted a share on OTCEI would be
receiving an Initial Counter Receipt.
• Buying Process in the Secondary Market: An investor desiring to purchase
shares listed on OTCEI in the Secondary market would have to first get himself
registered at any of the counters if he has not already registered himself. Then he
can approach any of the counters of OTCEI situated in any part of the country and
specifies the scrip name and the quantity that he desires to purchase. The investor
can specify the price range for the scrip he wishes to purchase. When the
transaction takes place, the investor is given a Permanent Counter Receipt (PCR).
• Selling Process in the Secondary Market: An investor, who has been allotted
securities or who has purchased securities in the secondary market, can approach
any of the counters situated in the country and fill in a Order Request From
specifying the scrip name and the quantity that he desires to sell. The investor has
to surrender the PCR + Transfer Deed (TD) to the counter. In case, the PCR is a
non-transferred PCR, then the investor has only the PCR to surrender. The
counter makes payment to the investor after registrar’s validation of the signatures
on the PCR.

The OTCEI Composite Index:

The OTCEI composite index has been introduced. as a broad parameter for investors and
analysts. It acts as an indicator of the market movement. The base date for the OTC
Composite Index is 23rd July, 1993 when the index was 100. The scrip’s included in the
OTCEl composite index are only listed equities.

Market Makers on OTCEI:

A market maker on the OTCEI is somewhat akin to a jobber on the regular stock
exchange. Their job is to provide two-way-buy and sell-quotes for a scrip and provide
liquidity. Any OTCEI counter can be a market maker. The idea is to create an
environment of competition among market makers to produce efficient pricing and
narrow spreads between buy and sell quotations. The market makers analyse the
companies and provide information about them to their investors thus generating
investor’s interest. The market makers are required to give quotes for a minimum depth
of three market lots. There are three types of market makers : Compulsory Market Maker
(CMM), Additional Market Maker (AMM) and Voluntary Market Maker (VMM).

“Bought-out-deals” on the OTCEI:

Floating public issue in the primary market involves a lot of formalities and a time lag of
at least 3-4 months. In case, where a company wants to get money earlier, it can find a
member of the OTCEI, who would be interested in acting as a Sponsor for the Company
to get it listed on the OTCEI. As a Sponsor, the member would ‘buy out’ the total equity
which the company intends to offer to the public. The member would later sell the shares
of the company to the public through an ‘offer for sale’. This method of getting listed on
OTCEI is also called a ‘Bought-out-Deals’. Sponsors can be authorised members of the
OTCEI or a Merchant Banker. They acquire shares in the bought out arrangement and
off-load it at a pre-determined price. They provide funds to the promoters and make them
free of issue responsibilities. Thus, sponsors act as an important intermediary in
mobilisation of savings.

Benefits to a Company listed on OTCEI:

• Fast way to get money, as the company does not have to wait for 3-4 months like
in regular public issue.
• No worry about under-subscription of the issue.
• Issue cost depends on negotiations with members.
• A new promoter with no track record can get a premium in the market if the
sponsor finds the project promising.
• The company need not have an established name in the market to sell the issue.
The issue sales based on the market reputation of the sponsor.

Benefits to an OTCEI Member:

• Sponsor can buy the shares of the company and sell it at a later time at a premium.
For example, a sponsor has bought shares of a company at Rs. 10, if the company
does well in six months, and the market conditions of coming out with a public
issue are favourable, then the member can sell the shares at Rs. 16 at a later stage,
and thereby making a profit of Rs. 6 per share.
• At the time of the issue, the sponsor need not appoint underwriters to the issue,
and can save on underwriting costs.
• The sponsor can time the issue and come in the market when the market
conditions for a primary issue are favourable.
 • There is no restriction on the holding period. The sponsor can hold the shares for
as long as he wants.
• For good projects, the sponsor can help the company to get premium in the
market.

Clearing & Settlement Process in stock markets:

As we all know, Stock Exchange is an entity which facilitates dealing in securities.

Dealing in stock exchanges is done through registered members (also called brokers),
who transact business primarily on behalf of their clients (or investors). For those who
are actively involved in stock market trading, it's always advisable to know the processes
involved in it.

Clearing and Settlement activity constitutes the core part of equity trade life cycles. After
any equity deal is confirmed (when equities are obliged to change hands), the broker who
is involved in the transaction issues a Contract Note to the Investor which has all the
information about the transactions in detail, at the end of the trade day. In response to the
Contract Note issued by broker, the investor now has to settle his obligation by either
paying money (if his transaction is a buy transaction) or deliver the shares (if it is a sell
transaction).

Clearing House is an entity of the stock exchange through which settlement of equities
happens. The details of all transactions performed by the brokers are made available to
the Clearing House by the Stock Exchange. The Clearing House gives an obligation
report to Brokers and Custodians who are required to settle their money/securities
obligations with the specified deadlines, failing which they are required to pay penalties.
This obligation report serves as statement of mutual contentment.

Settlement cycle is the period for which equities are traded in Exchange. For Indian
stock exchange NSE, the cycle starts on Wednesday and ends on the following Tuesday,
and for BSE the cycle starts on Monday and ends on Friday. At the end of this settlement
cycle period, the obligations of each broker are calculated and the brokers then settle their
respective obligations according to the guidelines, laws and regulations institutionalized
by the Clearing agency

Pay-In is a process where by a stock broker and Custodian (in case of Institutional deals)
brings in money and/or securities to the Clearing House. This forms the first phase of the
settlement activity

Pay-Out is a process where Clearing House pays money or delivers securities to the
brokers and Custodians. This is the second phase of the settlement activity
The whole set of money transaction is performed by a bank in the Stock Exchange
premises. Exchange appoints this bank to handle the money part of the transaction.

All the above information is mostly in relation to the Indian Stock market. Sometimes in
different countries processes may have some deviation from it, but the basic
fundamentals behind the whole process remains same. In India, the Pay-in of securities
and funds happens on T+ 2 by 11 AM, and Pay-out of securities and funds happen on
T+2 by 3 PM.

Circuit filter is applied to all the shares to supposedly safeguard the interests of general
investors
from the extreme volatilities in markets by preventing any unexpected fall or rise in a
single day beyond a limit. If the limit is crossed by any of the shares in a single trading
day it is frozen for trade.

A major characteristic of circuit-breakers is that it halts trading when the limits are
reached. On the contrary a circuit-filter is a ceiling fixed on price movement. In other
words assume a stock is trading at Rs 100. If the circuit ``breaker'' level is around 5 per
cent, then trading will stop if the stock touches either Rs 95 or Rs 105. If the circuit
``filter'' level is around 5 per cent, then it only means that traders cannot bid/ask quotes
below Rs 95 or above Rs 105. Hence, if traders are willing, they can still trade within the
prescribed band.

Are circuit-filters essential? Probably not. For instance when information on the true
value of the stock is publicly available, it would make perfect sense for the market to
realign itself. The need for circuit-filters can be questioned on several grounds. For
instance, empirical evidence on the effectiveness of price limits, circuit-breakers and
trading halts is ambiguous. But in the case of specific situations where it is clear that the
equilibrium value of the asset will change, as in the recent market situation with penny
stocks, it makes no sense to set circuit-filter limits. In fact, it goes against the objective of
improving liquidity in the market. In the absence of artificial price limits, the prices
would have realigned sooner, thereby bringing more liquidity in to the market.
Circuit Limit/Breaker System in Stock Market

SEBI has a rule called Circuit Breaker in Stock Market for both Index and Stock specific
Circuit Limits. The Circuit filter limit is introduced in intention to reduce the speculations
in the market and stock specific trading. There will be two ways a circuit filter applied,
upper circuit filter and lower circuit filter. So when buying stocks in the current stock
markets you must first learn about the stock market and know the stock market prices and
then consider online trading stocks.

Index specific Circuit Filter

Index specific circuit filter applied to either BSE Sensex or the NSE S&P CNX Nifty
whichever is breached earlier. Now there are three filters for Index based circuit viz 10%,
15% and 20%.

If either BSE Sensex or NSE S&P CNX Nifty falls 10% before 1.00pm then trading halts
for one hour in the market. If index drops after 1.00pm but before 2.30 pm then trading
halts for half hour. If the index drops after 2.30pm then there will be no halt for trading at
10% level and market shall continue trading for the remaining time.

If either BSE Sensex or NSE S&P CNX Nifty falls 15% before 1.00pm then trading halts
for two hour in the market. If index drops after 1.00pm but before 2.00 pm then trading
halts for one hour. If the index drops on or after 2.00pm then there will be no trading for
the remaining time.

In case of 20% drop in either of the index then the trading halts for the remaining day.

This percentage of circuit filters are revised after every quarter and new percentages are
arrived for the next quarter.

Stock specific Circuit Filter

Stock specific circuit filters are applied in both BSE and NSE index, the percentage for
circuit filter limit is 2%, 5%, 10%, 20%. When a stock is on upper circuit limit then there
will be only buyers in the market and no seller exists and hence the price is up. On the
other hand lower circuit limit is when there are only sellers in the market for that stock
and hence the stock price is down.
Filter of securities

NSE Daily Circuit Filters - 5% Circuit Filter Stocks

Circuit Filters or Daily Circuit Filters sets the limit to fluctuations of stock
prices. Circuit filters are set by stock exchanges to stop any unduly rising or falling of a
stock price.

They are numeric percent limits set on individual scripts. National Stock Exchange of
India (NSE) define circuit filters in 5 categories including 2%, 5%, 10%, 20% and no
circuit filter.

Circuit filters works in either ways. I.e. if circuit set for equity is 10%, stock price cannot
move further +10% to lower then -10%.

Circuit filter changes every day and stock keeps moving between one circuit filter
categories to other based on previous day’s closing price. Below is the list of current
circuit filters at NSE:

Market wide

How the index-based circuit filter works

Our Bureau

Mumbai , May 17

THE stock market today saw the use of index-based circuit breakers for the first time
after they were introduced on June 28, 2001.

The circuit breakers get activated at three stages of index (NSE Nifty or BSE Sensex)
movement either way at 10 per cent, 15 per cent and 20 per cent. The circuit filters
trigger a co-ordinated halt in trading in all equity and equity derivative markets
nationwide.

Today the first circuit filter was activated within 20 minutes of opening or when the
Sensex fell 550 points. The next was triggered within two minutes of resuming trading at
11.15 a.m.

The percentages are calculated on the closing index value of the quarter. These
percentages are translated into absolute points of index variations (rounded off to the
nearest 25 points in case of Sensex). At the end of each quarter, these absolute points of
index variations are revised and made applicable for the next quarter.
On March 31, 2004, the last trading day of the quarter, the Sensex closed at 5590.60
points. The absolute points of Sensex variation (over the previous day's closing) which
would trigger market wide circuit breaker for any day in the quarter between 1st April
2004 and 30th June 2004 are: 550 points for 10 per cent 850 points for 15 per cent and
1,125 points for 20 per cent.

In case there is a 10 per cent movement of wither the NSE Nifty or the BSE Sensex,
trading is halted for an hour if the movement is before 1 p.m. In case the movement takes
place at or after 1 p.m. but before 2.30 p.m. trading is stopped for half hour. In case the
movement takes place at or after 2.30 p.m. there will be no trading halt at the 10 per cent
level and the market will continue trading.

In case of a 15 per cent movement of either index, there will be a two-hour market halt if
the movement takes place before 1 p.m. If the 15 per cent trigger is reached on or after 1
p.m. but before 2 p.m., there will be a one-hour halt. If the 15 per cent trigger is reached
on or after 2 p.m. the trading will halt for the rest of the day. In case of a 20 per cent
movement of the index, the trading will be halted for the rest of the day.

More Stories on : Stock Markets

Market Wide Circuit Breakers

The earlier Circuit Filters at individual scrip level used to restrict the movements of indices as
well. Now, there are no Circuit Filters on the scrips forming part of popular indices like SENSEX.
In order to contain huge price movements of index scrips, SEBI has mandated that Market Wide
Circuit Breakers (MWCB) which at 10-15-20% of the movements in either BSE SENSEX or NSE
Nifty whichever is breached earlier would be applicable. This would provide a cooling period to
the market participants and to assimilate and re-act to the market movements.

The trading halt on all stock exchanges would take place as under;

- In case of a 10% movement in either index, there will be a 1-hour market halt if the movement
takes place before 1:00 p.m. In case the movement takes place at or after 1 p.m. but before 2:30
p.m., there will be a trading halt for 1/2 hour. In case the movement takes place at or after 2:30
p.m., there will be no trading halt at the 10% level and the market will continue trading.

- In case of a 15% movement in either index, there will be a 2-hour market halt if the movement
takes place before 1:00 p.m. If the 15% trigger is reached on or after 1:00 p.m. but before 2 p.m.,
there will be a trading halt for 1 hour. If the 15% trigger is reached on or after 2:00 p.m., the
trading will halt for the remainder of the day.

- In case of a 20% movement in either index, the trading will halt for the remainder of the day.

The above percentage would be translated into absolute points of the Index variation on a
quarterly basis. These absolute points are revised at the end of each quarter

The Market Wide Circuit Breakers at a national level have been introduced in the Indian markets
for the first time. This is on the lines of the system prevailing in the US markets.
Individual Scrip Circuit Filters

Circuit Filter of 20% is applicable on all scrips except the scrips on which derivative products are
available and are part of indices on which derivative products are available. However, BSE
imposes dummy circuit filter on these scrips to avoid punching errors, if any.

TOP

CONTRACT NOTES

Contract Note is a confirmation of trades done on a particular day on behalf of the client
by a trading member. It imposes a legally enforceable relationship between the client and
the trading member with respect to purchase/sale and settlement of trades. It also helps to
settle disputes/claims between the investor and the trading member. It is a prerequisite for
filing a complaint or arbitration proceeding against the trading member in case of a
dispute. A valid contract note should be in the prescribed form, contain the details of
trades, stamped with requisite value and duly signed by the authorized signatory.
Contract notes are kept in duplicate, the trading member and the client should keep one
copy each. After verifying the details contained therein, the client keeps one copy and
returns the second copy to the trading member duly acknowledged by him.

LIMIT ORDER
As you've seen, you are at the mercy of the marketplace when you jump in to buy or sell
stock. But to a certain extent, you can control your price. Most new investors place
market orders, just buying or selling at the moment's current price. But you can place a
limit order, in which you name the price that triggers your order to buy or sell.

For example, say IBM is quoted right now at $80. You decide that if it drops to $76,
you'll buy 100 shares. You can give your broker a limit order to buy 100 shares of IBM at
$76 or lower (called “better”). This is a “buy order of 100 IBM at 76”. Nothing happens
unless IBM's price drops to $76 or lower.

If you want to sell your shares for $90, you would give your broker a sell order for $90.
Once again, nothing happens unless the share price goes up to $90.

Many investors, when buying a stock, will immediately place a sell order at a price below
what they paid for it. This is known as a “stop loss order” or a “stop sell” or a “sell stop”.
For example, if you bought IBM at $80 and wanted to protect your investment, you could
give your broker a stop order at $75. If the stock drops to $75, it will automatically sell,
thus limiting your loss. As soon as the order is triggered, your broker would sell your
shares at the best price available, which may actually be a little lower or even a little bit
higher by the time your order to sell is matched with a buyer. A stop order would have
protected holders of Best Buy, the nation’s largest electronics retailer, on Aug 8, 2002
when the share price dropped $11.25 to $19.55 in just one day (37%).

When you place a buy or sell limit order with your broker, you specify that it is a day
order (for today only), or a GTC order (good till canceled).

Margin Loans and Investment

Your broker wants to lend you money, lots of money, using your stocks as security. You
can use the money for whatever you want - anything. The interest rate is usually under
10% a year, which is reasonable. This is called a margin loan.

If you have at least $5,000 (a few allow as little as $2,000) in cash and investments in
your account, you can use available margin to increase your profits. But using margin
doubles your risk!
Federal regulations allow up to 75% of your account to be margined. Most brokers hold
the line at 65% (new accounts 50%), with your equity being 35%, and most brokers won't
count stocks trading at under $5.00 as part of your equity.

If the value of your account drops below the broker's minimum percent, you would
receive a "margin call" asking you to add more cash. If you can't bring your account up to
snuff, the broker will sell shares to cover the loan and interest.

Available margin is called "buying power", and is not the same as "cash available". Each
broker has his own way of calculating your buying power, and they base it on your length
of time with the broker, the size of your account, and the quality of your securities.

Speculators use margin to try to double their profits. This is very risky. If you guess
wrong, you are doubling your losses, even wiping out your original investment. Margin is
not for new investors.