Buying stocks on margin simply means buying stocks with the use of borrowed money. First the investor has to open a margin account with a margin provider by pledging the existing portfolio against the margin facility. In this process the client enters in to a tri-party agreement with the Stock Broker and Margin Provider. Certain margin providers request you to open a separate CDS account for this purpose and request you to transfer shares in to this account but some providers would allow you to operate the facility with the existing CDS account.
Depending on the size and the quality of the portfolio the margin provider grants you a loan facility which you can use for the purpose of buying quoted shares. As per the regulations, the maxim amount of allowable margin is 50%, which means the total borrowing should not exceed the value of the portfolio in excess of 50%. The margin Provider charges interest for the utilization of the loan facility, calculated on a daily basis.
Assuming your portfolio comprises of 10,000 shares of XYZ and currently the share is trading at Rs. 100/-, the value of your portfolio would be Rs. 1,000,000/-. Obtaining a margin facility of Rs. 800,000/- would give you the opportunity to buy shares up to the value of Rs. 1,800,000/-. Also, buying a further 8,000 shares gives you the opportunity to hold 18,000 shares of XYZ. Assuming the share price increases to Rs. 110/- within a week, you will hold a profit of Rs. 180,000/-, whereas without a margin trading facility, you would have only held 10,000 shares with a profit of only Rs. 100,000/-. Purchasing stocks on margin allows the investor to leverage a position and realize greater profits.
Buying on margin does give the potential for greater profits but there is also the possibility of running in to a greater risk. In the event the price of stocks purchased on margin declines significantly, the investor could actually lose more than the initial investment.