Difference Between Margin Trading and Leverage

Understand the difference between margin trading and leverage to explore how each approach affects buying potential, risk exposure, and capital requirements.

Margin trading and leverage are two widely used concepts in stock market trading, especially among active traders and investors who aim to amplify returns. Although both involve borrowing capital to increase exposure, they operate differently and serve unique purposes. Understanding the distinction is important because both can magnify profits—but also significantly increase risk.

Margin trading is a facility that allows traders to borrow money from a broker to purchase more securities than their available capital permits. The trader must deposit a certain percentage of the total trade value, called margin, while the broker funds the rest.

Margin trading is commonly used in:

• Intraday trading
  

• Short-term directional bets
  

• Volatile market opportunities
  

• Leveraged investment strategies

Key characteristics of margin trading

• Requires an initial margin deposit
  

• Securities purchased act as collateral
  

• Interest is charged on the borrowed amount
  

• Trades may be squared off the same day or carried forward (depending on rules)
  

• Subject to margin calls if market moves unfavourably

Margin trading follows a straightforward mechanism:

1. Trader places a buy order using the margin trading facility.
   

2. Broker contributes the remaining capital needed for the trade.
   

3. Securities are purchased and held as collateral.
   

4. Trader must maintain a minimum margin (SPAN + Exposure, depending on exchange).
   

5. If prices fall, the broker may issue a margin call.
   

6. If margin is not restored, the broker can square off the position.

Key pointers

• Initial margin ranges from 10%–40% depending on volatility.
  

• Interest rates for margin funding vary across brokers.
  

• Brokers follow exchange-mandated risk and settlement rules.

This mechanism allows traders to take larger positions than their cash balance.

Suppose a trader wants to buy shares worth ₹1,00,000, but has only ₹20,000.

If the broker offers 5x margin, the trader can still purchase:

₹20,000 × 5 = ₹1,00,000 worth of shares

If the stock rises 5%:

• Profit = ₹5,000
  

• On investment of ₹20,000, return = 25%

If the stock falls 5%:

• Loss = ₹5,000
  

• On investment of ₹20,000, loss = 25%

This shows how margin amplifies both gains and losses.

Leverage refers to using borrowed capital or financial instruments to increase a trader’s exposure relative to their available capital. While margin is a type of leverage, leverage itself is a broader concept.

Leverage is expressed as a ratio, such as 2x, 5x, 10x, or even 100x (in forex and crypto).

Key characteristics of leverage

• Helps control a larger position with smaller capital
  

• Used in derivatives like futures, options, and forex
  

• Can magnify returns significantly
  

• Involves high risk if market moves against the trader
  

• Requires strict risk management practices

Unlike margin trading (which is mostly equity-based), leverage applies across multiple asset classes.

Leverage multiplies a trader’s exposure. For example:

• With 10x leverage, ₹10,000 allows exposure of ₹1,00,000
  

• With 20x leverage, ₹10,000 controls ₹2,00,000 worth of assets

Formula:

• Exposure = Capital × Leverage

If the position moves:

• +2%, trader earns 20% profit (at 10x leverage)
  

• –2%, trader suffers 20% loss

Thus, leverage raises both the reward potential and the risk significantly.

These benefits highlight how leverage can expand trading opportunities:

1. Increased Buying Potential

Allows traders to take larger positions than their cash balance permits.

2. Enhanced Return Potential

Small market moves can generate substantial percentage returns.

3. Opportunity to Trade High-Value Stocks

Leverage allows traders to take positions in higher-priced stocks.

4. Efficient Capital Utilisation

Free capital can be allocated to multiple trades simultaneously.

5. Portfolio Diversification

Leverage allows exposure across multiple sectors or instruments.

These risks commonly arise in margin trading:

1. Amplified Losses

Losses increase proportionally with leverage—sometimes wiping out entire capital.

2. Margin Calls

If equity falls below the maintenance margin, traders must add funds immediately.

3. Interest Costs (Margin Trading)

Interest on borrowed funds reduces net returns.

4. Forced Liquidation

Brokers may square off positions without permission during adverse movements.

5. High Volatility Exposure

Leverage in volatile markets increases potential risk, particularly for inexperienced traders.

A margin calculator helps traders determine:

• Required margin
  

• Maximum buying potential
  

• Leverage applicable
  

• Interest cost (if applicable)
  

• Quantity they can purchase

Example:

If margin requirement is 25%, and you have ₹40,000:

Buying potential= ₹40,000 ÷ 0.25 = ₹1,60,000

This determines the margin requirement and potential trade size.

Before analysing leverage risk, it’s essential to understand these core building blocks:

1. Initial Margin

The minimum deposit required to open a leveraged position.

2. Maintenance Margin

The minimum equity balance required to keep the position open.

3. Margin Call

A warning from the broker to add funds due to falling equity.

4. Stop-Loss

A risk-management tool to limit losses in leveraged trades.

5. Liquidation Level

The price at which the broker forcibly closes the position.

6. Exposure

Total market value controlled using leverage.

These concepts ensure safe and informed trading.

Margin trading and leverage both allow traders to increase their market exposure beyond personal capital. While they can boost returns dramatically, they also raise the risk of rapid losses.

Key takeaways:

• Margin trading = borrowing funds from a broker.
  

• Leverage = broader concept of amplifying exposure through borrowing or financial instruments.
  

• Both offer higher return potential but come with significant risk.
  

• Risk management—stop-losses, hedging, and proper margin planning—is essential.
  

• Effective use of leverage depends on understanding market dynamics and associated risks.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.