What is the meaning of credit balance of trading account?
What is a Credit balance?
A credit balance is a difference between the current account balance and the debit balance. The credit balance of a trading account is the amount credited to his margin account after completing a short sale.
A short sale margin account contains both the proceeds of the short sale and a specified margin amount deposited by the customer following the successful execution of the short sale order.
Credit Balances: An Overview
Cash and margin accounts are used to buy and sell financial assets. Trading in a cash account is limited to the amount of cash available to the investor. The investor can only purchase shares worth Rs. 500 in their account, including commissions, if they have Rs. 500 in their account.
When it comes to a short sale, margin accounts allow the trader or investor to borrow money from their broker to buy additional shares. An Rs. 500 investor may wish to purchase shares worth Rs. 800 with his Rs. 500 cash balance. In this case, using a margin account will lend them Rs. 300.
Margin accounts with only short positions show a credit balance, while margin accounts with long posts show a debit balance. Cash proceeds from a short sale are added to the margin requirement to calculate the credit balance.
Selling shares on the open market after borrowing them from a broker constitutes short-selling. Later, the repurchase of shares happens at a lower price, and the broker will pocket any excess cash. The investor receives the proceeds of the short sale in his margin account when the shares are sold short for the first time.
Aspects to Consider
- A margin account combines short sale funds and margin money that always shows a credit balance.
- In the stock market, margin accounts are different from regular trading accounts.
- The broker can also lend client securities or money through a margin account. A credit of short sale funds can also happen to the credit balance after the short sale execution.
- A margin account can contain money credited upon a short sale of securities and a margin maintained by a client.
- The client must deposit an additional margin when the margin falls below the required amount.
- The margin account allows a trader to borrow money from a broker to buy additional shares or to sell securities borrowed from the broker. This differs from a cash account, where securities can only be purchased and sold with the available cash balance. Buying shares worth Rs 15000 with Rs 10,000 in cash and another Rs 5,000 from his brother is possible for an investor with Rs 10,000.
- In contrast to an extended position with a debit balance, a margin account with a short position will have a credit balance.
You can buy securities A with an initial margin of 50% if you deposit Rs. 1,00,000 into your trading account. This means that your trade limit is Rs. 2,00,000. You are self-financing 50% of the investment position with your capital and borrowing the remaining 50%.
Brokers retain custody of stock purchased as collateral and charge debit interest on borrowed funds. Buying securities 'A' with Rs. 2,00,000 borrowed money will change the whole amount from collateral to borrowed money if you use Rs. 2,00,000 to purchase securities as collateral.
List of Marginal Stocks
Due to their diverse fundamentals and liquidity, the market has established a list of marginal counters to limit exposure to risks associated with individual stocks. Updation of investing news happens monthly with the list of marginal 'quality' stocks that are graded and have multiple margin rates.
List of Marginal Stocks Margin Financing Charges in Trading Accounts
Your outstanding account balance at the end of each trading day will be used to calculate interest at the specified rate. At the end of each month, Reconciliation of your account happens to determine whether you earned a draw or had to pay interest. Account statements will be mailed to you monthly so that you are aware of the progress of your investment.
- Credit Balance of trading account: Interest earned on your account's outstanding cash balance.
- Debit Balance: Margin loans require payment of interest.
Cautions While Using Credit Balance of Trading Account:
Margin investments in investment accounts are risky propositions with equal odds of profit or loss. To make informed investments, investors should take the time to research securities before purchasing them on margin.
Consider the following example: You put 100 INR into stocks in your cash account and close out the position to reduce your loss when the stock drops 20%. As a result, your account will have INR 80 remaining.
What happens if you buy stocks in a trading account on margin? The broker will retain custody of your securities as collateral if the initial margin is 50%, so your buying power will double. Your account will have INR 160 left after the stock falls 20%, so you lose INR 40. When you sell the securities to cut your losses, you will be able to pay off the INR 100 debit balance with only INR 60 remaining.
If the stock increases by 20%, its value will increase to INR 120. If securities sell on a cash account, a gain of INR 20 is made. A trading account that buys securities on credit for INR 200 will earn you INR 40 in profit if the price goes up 20% to INR240. The credit balance of the trading account indicates profit/losses multiplied by cash account profits/losses (minus interest) when interest is applied.
- Debit balances or interest rates may fluctuate up and down, which can increase your investment risks. To offset the interest risks, investors should buy the 'right' stocks at the 'right' time by investing in the 'right' stocks at the 'right' time.
- Among the key factors that investors should consider before investing are the terms of the credit balance account agreement regarding the approval of marginal securities and the multiple margin rate.
- Margin trading in credit balance accounts is primarily based on maintenance margin (MM). You must top up funds or collateral into your Credit balance account if the equity balance in your account drops below the MM level specified in your contract. The credit balance will liquidate any open positions in your account if the margin requirement is not met without your consent to pay back debts until equity meets the margin requirement. Investors should carefully monitor their portfolio to prevent this capital loss and accept the Credit balance's terms and conditions. On this basis, the force-selling margin is known.