Margin is an upfront payment made to enter into a transaction. Suppose you want to buy 100 shares of Reliance Industries and it is currently trading at say Rs. 1000, you will be required to pay an amount of Rs. 20000, if the margin charged is 20% on transactions of Reliance shares. The margin is paid by the investors/traders who take position in the stock market. Taking position means buying or selling shares. The margin trading is available even in the online trading portals like,' Icicidirect',' Sharekhan' etc.
How is the margin decided for shares of a company? Is it same for all the shares? Please note that the margin is charged for each share depending upon the volatility of the share price.( Margins is charged for both buy and sell transactions of a share). Volatility refers to uncertainty arising out of price changes of shares. Volatility takes into consideration both upside as well as downside movement in the price of a stock. The volatility is calculated using a statistical tool called as,' Standard Deviation'. The standard deviation takes into consideration the daily movement in the price of the stock and then provides the standard deviation of a stock.
In the share market or the cash market, there are three types of margins which an investor is supposed to pay:
1) Value at Risk Margin
2) Extreme Loss Margin
3) Mark to Market Margin
Let us try to understand what is meant by 'VaR'. While volatility talks about how the price has moved in the past, Value at Risk (VaR) answers the question, "How much is it likely to move over next one day?"
VaR is a technique used to estimate the probability of loss of value of an asset or group of assets (for example a share or a portfolio of a few shares), based on the statistical analysis of historical price trends and volatilities. VaR basically tries to answer the question,' With 99% confidence, what is the maximum value that an asset or portfolio may loose over the next day?'.
VaR margin is charged separately for Group 1, Group 2 and Group 3 stocks. Group 1 stocks have lowest margin to be paid while the margin in case of Group 2 stocks are higher and in case of Group 3 stocks it is the highest. This is calculated with the help of a formula.
Extreme Loss Margin (ELM) covers the losses which are could occur outside the coverage of VaR margin. It is mostly 5% percent but can be higher depending upon the stocks. This is also calculated through a formula.
Mark to Market (MTM) margin is calculated through a formula which is as follows:
MTM Profit/Loss = [(Total Buy Qty X Close price) - Total Buy Value] - [Total Sale Value - (Total Sale Qty X Close price)]
Margins play a very significant role in the functioning of stock market as they are used as risk management tools. Without margins, the transactions in stock market can become very risky.
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