Today, margin transactions in the securities market occupy more than 50% of transactions in the stock segment. This is the most common tool to improve the efficiency of investment operations.
Margin trading or Margin trading - a type of speculative operations, which implies the use of broker's funds (in the form of money or securities), which customers take in a loan for the operation. Funds transferred by the broker to the investor as a guarantee of a specific amount - margin.
Margin differs significantly from an ordinary bank loan in that its size is several tens of times lower than the amount of the first installment for lending. Often, the starting collateral amount, which is enough for the broker, is 2-3% of the investment amount. This allows a novice investor to repeatedly increase the volume of trading operations with modest capital. But the agreement between the broker and the investor implies a lot of mutual rights and obligations.
The essence and procedure for conducting margin transactions
In fact, a marginal transaction is made by a stock market expert (broker) and a client (investor himself) on mutually beneficial conditions.
An expert can attract his own financial resources to the stock transaction of his client to increase the profitability of the transaction itself.
Such brokerage lending, of course, is also carried out on bail. Most often, pledges are securities that are already purchased by the client and are held by a broker, real money or even rights to use certain property.
The essence and procedure for conducting margin transactions can be explained as clearly as possible only by example.
for example. There is such an entrepreneur P. He is absorbed in the phobia of instability of the national currency and prefers to convert most of the income into dollars. He has a friend D. He works as a cashier in a bank. And when there is a certain amount of currency at the cash desk at a reasonable rate, he can offer it to P. So D. calls P. and says: “Today, there are $ 5,000 in cash at 50 rubles each. Interested in? "
P. answers him: “Of course, he is interested, but I'm on a trip, I will not be there for three weeks. Buy me, please, for yours. And I will give it back. But you have another $ 300 that I keep with you, they will be a guarantee. ”
D. buys currency for his money and receives his commission, P. buys currency at a favorable rate. Moreover, all three weeks D. can dispose of these 5 thousand at their professional discretion. Can resell them if the rate rises and buy again when the rate drops again or attach to a short deposit.
In the stock market, the transaction takes place in a similar way, only the parties to the contract: the investor and the broker, and the goods are securities.
What is margin, margin account? Conditions and procedure for obtaining a margin loan
Margin - part of the investor’s own funds in a transaction using the broker's financial resources. In fact, this is what the investor invested. Margin for a broker is a kind of deposit, a guaranteed deposit, which the client transfers to the broker to secure his current and future obligations under the transaction.
Naturally, like any agreements related to loans and credits, margin transactions with securities are concluded only on the basis of a strong contractual relationship between the broker and the client.
The main form of the contract is a civil contract for opening a margin account. Also, the terms of margin trading can be determined by the broker service agreement.
The investor, under the terms of the contract, is able to finance his purchases of securities using brokerage loans.
As a guarantee for the broker, the generally accepted collateral rules apply. A pledge may be part of a client’s finances, as well as his securities issued by a broker.
The fact is that securities purchased during margin transactions are registered with a broker, they are on the balance of the margin account. Due to this, both the broker and the investor himself have the right to make secondary short transactions, administrative transactions with these securities.
The broker receives his commission from the purchase / sale of securities, as well as all income from administrative transactions.
The investor bears all investment risks, but he receives the main profit: it is the client who retains the right to receive dividends and other share rights.
What is leverage?
Leverage or Leverage this is the ratio between the amount of margin purchase and the amount of borrowed capital. In fact, margin + leverage = the sum of the margin transaction. But this ratio is most often indicated as a coefficient. For example, the investor’s share in the transaction is 20%, in which case the leverage will be 1: 5.
The term “shoulder” or “lever” is not used accidentally. With the help of a lever, as you know, even a very large object can be moved. So in trading with the opening of a margin account, the investor gets access to such operations that are absolutely impossible when using only your own financial resources.
The term “leverage” in margin trading is not used accidentally. It is known that with the help of a lever ("shoulder") it is possible to move a heavy object with small force, which would be impossible to move without such a lever.
The maximum possible leverage is 1: 1 when the investor and broker invest equal parts.
Margin lending forms
Margin transactions are transactions that may take the form of a purchase or sale.
Short purchase - the purchase of securities, during which the broker gives the client money on credit for the purchase of these same securities.
Short sale - a transaction in which a broker gives a client a loan in the form of securities.
Margin transactions in the securities market are permanently reverse operations. This means that a merchant who has access to a margin account, after buying shares, will certainly sell them at a better price and vice versa.
Also, they distinguish a specific type of margin trading - extension transactions. At the time of conclusion, they are no different from ordinary ones, but if by the end of the contract period the liquidity of the securities purchased by the investor does not suit him, he can extend the transaction by reducing the leverage.
Almost unsecured transactions, which are then secured from the margin account, can also be classified as marginal ones. Unsecured is a transaction at the time of which the investor has insufficient funds.
What securities are suitable for margin trading
In the stock market, the marginal principle is widespread, it is applicable when trading any instruments.
Margin transactions are concluded only on the exchange and are regulated by the Department of admission to the financial market of the Bank of Russia. The same authority determines the list of securities that may be subject to margin trading.
Most often, reliable and most importantly, highly liquid shares and bonds, blue chips, preferred shares of large companies included in the stock exchange quotation list become marginal goods.
Rarely, government bonds become such a commodity, since a limited list of operations can be carried out with them.
Margin transactions are transactions using a loan, which can be expressed as a real cash loan from a broker or a loan in the form of securities.Therefore, each broker, investment fund or other intermediary company that provides margin trading services has its own list of securities with which they deal. As well as a list of companies whose securities they agree to buy on credit.
State regulation of margin trading in Russia, the legislative framework
Margin transactions are classified as speculative operations, however, they are carried out within the framework of the legal framework and are regulated by a number of legislative acts:
- The Federal Law "On the Securities Market", which provides the designation of the concept of "margin trading" and describes the responsibilities of the broker and client.
- The Code of the Russian Federation on Administrative Offenses containing the requirements for transactions, with the designation of punishments for their violation.
- Judicial Practice Guide (Loan and Trust Management).
The regulatory framework for the stock market was developed only in 2002, although the practice of margin trading has a long history in our country. A significant part of margin transactions are still outside the scope of regulation.
In the United States, there are several more intermediary cells in margin trading. For example, brokers rarely risk their personal financial resources. For lending purposes, there are fund organizations in which a loan is taken against the security of the securities themselves purchased from a margin account.
Risks of Margin Transactions
Margin transactions are one of the most risky transactions, although they allow the trader to increase income many times, and the broker to get a solid percentage.
In the practice of margin trading, such operations are conducted only with reliable, highly liquid stocks and bonds.
The main pitfall of margin trading for a broker is the risk of non-payment by the client of the collateral. But the conditions in case of non-payment are prescribed in the contract between the broker and the trader.
In an unstable investment, the broker has the right to raise the margin to 20-30%, although when buying reliable stocks or a currency, the margin usually does not exceed 3%.
Sometimes, when the procedure for conducting margin transactions is violated due to the need to buy assets very quickly, for example, at open bidding, a broker can make an acquisition at the request of the client, but without a specific margin for the purchase. In this case, previous securities issued by a broker may serve as a pledge.
The risk for the investor is much higher than for the broker. Although, if the securities are risky, then they are risky both in the case of direct investment and in the case of a marginal purchase. The investor risks his share in the transaction (margin), as well as the collateral, which is often the previous securities and all possible income from the investment.
During the margin transaction, the broker acts as a very interested person, he carefully monitors the fluctuation of stock prices on the margin account. And when the prices of these shares fall, he immediately informs the client or even quickly resells the shares on his own.
The main risk of the broker depends on an adequate assessment of all the financial resources of the client provided as collateral. It is important for a broker to check the liquidity of securities. If a margin transaction is conducted by a new client, then it is necessary to correctly execute it with a loan agreement in writing. For regular customers, brokers, most often, prescribe the terms of margin trading in the contract for brokerage services.
Closing a margin transaction, under what conditions. Forced closing of a margin transaction
Margin transactions of the broker and client can be considered closed when a reverse transaction is made (repeated purchase or resale). In this case, we can talk about the bilateral completion of the transaction.
But, often the broker himself traces open positions, controlling the size of the risks.When the price of securities purchased during a margin transaction falls below the margin, the broker has the right to re-sell the shares.
Another broker can contact the client with the condition to raise the margin if the client wants to extend the ownership of securities purchased during the transaction. This appeal is called Margin call. When the investor does not respond or cannot reduce the leverage, the broker has the right to close some of the client's collateral positions.
In brokerage practice, there is a rule regarding customers who do not respond to margin calls. If the broker does not refuse to work with such an unreliable investor, he transfers him to the list of risky partners and assigns a leverage of 1: 1.
The next day, the broker excludes him from the list of clients with a high level of risk and assigns him a leverage of 1: 1.
Accounting of margin transactions in credit organizations
It is worth noting that the broker's marginal transactions are not provided with adequate regulatory regulation in accounting. In accounting practice, there are several methodological solutions. They are able to document margin transactions.
In banks, these transactions are often executed as ordinary trading operations by unsettled positioning of a repurchase agreement. Or on the basis of a loan loan agreement, the repayment of which is then displayed in reverse transactions.
Much more confusing is the boo process. accounting for margin transactions with pledged securities.
In legal practice, such operations are executed with the conclusion of a loan or commodity loan agreement. Margin transactions, due to their efficiency and dynamism, are often executed without a specific contract. But after the fact, for ease of reference. accounting, however, a loan agreement is concluded, since it is considered more variable than a commodity loan agreement. According to the State Code, failure to comply with the written form does not invalidate the loan agreement.
The financial result of margin trading, how the participants of the transaction distribute income
The distribution of income from margin trading occurs in an interesting way.
In the case of a positive (profitable) financial result, the broker receives the full amount of the loan, his commission for the services of an intermediary, and interest on the loan for all lines of use of his resources. The investor receives his share of the transaction, dividends on securities purchased during the transaction and money for their sale, minus the commission of the broker and the amount of the brokerage loan.
In case of a negative (unprofitable) result of a marginal transaction, the settlement of interests under the contract occurs. Most often, the broker reserves the right to sell collateral securities of the client in order to cover its losses. But, if the investment loss was caused by the gradual depreciation of securities, which the broker did not track, the investor has the right to compensation for his margin.
Due to the specific speculative nature of margin transactions, each such operation consists of two parts: opening a position and closing. This cycle is called full trade.
Margin transactions are speculative operations, they enable investors to carry out large-scale operations with limited financial resources. Short deals provide the trader with the opportunity to get quick, income and refresh their investment portfolio. But at the same time, margin trading is a risky type of stock transactions, such transactions decently damaged the nerves of more than one generation of traders and brokers.
Margin trading is also possible only in the case of a relatively stable investment market. For example, in 2008 in the Russian Federation and in a number of other countries laws were passed banning margin trading until stabilization in the stock and bond markets.In Russia, the Ministry of Justice carried out the relaxation and liberalization of these prohibitions only in the second half of 2009.