Margin Trading simply means using the borrowed money to buy securities for placing trades. Margin Trading Facility (MTF) is the facility offered by your stockbroker so that you never miss a good opportunity in the stock market due to a cash shortage. With MTF you can trade even with your limited funds.
Margin is the difference between the total value of stock held by the investor in his/her Demat account and the loan value from the broker. You can buy selected stocks at a percentage (margin) of the trade value and the rest amount of the transaction will be borrowed from your broker. As per the new SEBI guidelines, effective from Sep 1, 2020, you have to pledge stocks in favour of the broker before using them as margin.
Marginal Trading Account
You need a margin account to use MTF that is maintained separately from cash accounts. Brokers lend the money to investors in this account. Sale proceeds are collected by the stockbroker first and used for repayment of margin loan before you get any profit.
Benefits of Margin Trading
The opportunity to leverage assets
With margin facility, you can leverage your trading value and hence, potentially increase your profits on your trade.
MTF account facilitates short selling
You require a margin account for the short-selling of stocks. Short selling is an advanced trading strategy where traders seek to make profits from a declining stock that he does have. To sell a stock short, you first borrow stocks from your broker through a margin account.
Large unrealized capital gain
MTF helps to diversify your concentrated portfolio which may be dominated by a large number of shares of a company. You can use those large blocks of shares as collateral for a loan with your broker. Hence, it is a proceeding to diversify your portfolio without selling your original assets. Therefore, it is helpful if you want to utilize a large unrealized capital gain.
Your MTF interest rates will be lower as compared to any other lender that’s too without any paperwork and application fees.
The risk involved in Margin Trading
In the stock market, where there is a potential reward, there is a potential risk also. No doubt margin facility is useful and convenient but only when it is used with extra cautions as it is full of a risk just like other debts that include interest payments. Following are the risks involved in MTF:
Loss of more funds
In case you are deprived of your trade and facing losses instead of making profits, you have to pay more than what you got through margin loan i.e. losses + loan amount.
If the value of the stocks you are using as collateral in your brokerage account is less than the minimum equity maintenance requirement, you need to add cash or securities to increase its value because brokers are instructed by SEBI to maintain minimum equity in your account. If you are unable to do so, your account may incur a margin call and your broker can force you to sell securities in your Demat account. And the worst thing is that you cannot get an extension of time on a margin call.
Short- selling loss
Selling short can be costly if your guesses are wrong about the price movement of stocks.
The Bottom Line
Hence, MTF loss may not suit every investor. Here are some points, one must consider before using MTF:
- Do not invest what you can not afford to lose.
- Do not touch the maximum limits of MTF.
- Short-term borrowing only to minimize costs.
- Research stocks carefully before using MTF for it.
- Do not consider it as a cash cushion.