Margin Trading Facility (MTF) is when you borrow money from any brokerage company, and it can only be utilised to buy stocks through their app or platform. In simple terms, you take a loan from your stock market broker to increase your buying power for stocks, which you later repay with interest.
It is also referred to as leverage trading, which is the same as mortgages and loans, where you keep something as security to borrow money. In leverage, you give your existing positions as security to borrow more money to invest or trade in the stock market.
In this blog, we have covered all the features & benefits of margin trading: what is pledge holding, how much margin is required for share trading, how many days you can pledge shares and some risks you should be aware of. Let’s get started.
How does Margin Trading work?
Margin trading facility, or MTF, is mainly about borrowing money to buy more stocks, and it works in a few simple steps:
- Collateral for lending: In traditional loans, you pledge owned assets to borrow money. In margin trading, you use your existing shares as collateral. Your broker decides the trading margin amount based on the value of the shares in your demat account.
- Increase in buying power: With margin trading, your buying power increases without investing additional capital. Assume you have stocks of ₹1,00,000, and your broker offers a 1:2 leverage. This means you can now buy stocks of ₹2,00,000 without additional money.
- Interest on borrowed amount: While buying stocks on margin, you need to pay interest on the borrowed money. Different brokers have different interest rates for margin trading in India, so you must compare and choose the lowest MTF interest rate. The interest is typically calculated daily, and you will repay it with the loan amount.
- Holding the borrowed shares: You can hold the borrowed shares only for a certain period. It entirely depends on your broker. Some brokers may require you to repay the loan sooner, while others can offer an extended period for margin trading.
Benefits of Margin Trading
Margin trading can be attractive, especially if you are looking to boost your investments without adding extra cash immediately. Here are some of the key benefits:
- Increased Buying Power: The main advantage of margin trading is the increased buying power it provides without putting any additional money. If you have ₹1,00,000 in your account and leverage that amount, you can effectively invest ₹2,00,000 or even more, depending on the ratio offered. This allows you to take advantage of bigger opportunities in the stock market.
- Potential for Higher Profits: When used correctly, buying stocks on margin can lead to higher profits. By investing more than your available funds in your demat account, you can gain from a larger portion of the market’s rise. For example, if you’ve bought stocks using margin trading and the stock price goes up, you profit from both your initial investment and the borrowed funds.
- Flexibility in Investments: Using an MTF app offers flexibility. You can buy stocks from a broader portfolio without selling any existing shares, allowing you to diversify and hedge your bets without needing immediate liquidity.
- Works for Both Short-Term and Long-Term Traders: No matter if you are a day trader or a long-term investor, MTF caters both. Short-term traders can utitlise the extra trading margin to benefit from quick market moves, while long-term investors can capitalise on big opportunities in growth stocks.
Risks Involved in Margin Trading
While margin trading sounds great, there are some risks involved. Before jumping in, you should know what you’re getting into:
- Increased Losses: Just as MTF can increase your profits, it can also increase your losses. If the stock price goes down, you’ll lose not only your investment but also the borrowed money. This can be particularly harsh during market downturns.
- Interest Payments: Always remember that you are using borrowed money, and that comes with interest. Over time, the interest you pay can take away all your returns. You could have a net loss if your stock doesn’t perform well enough to cover the interest. That’s why it’s crucial to seek brokers with the lowest interest rate.
- Margin Calls: Suppose, the stocks you have pledged as collateral drops too much, your broker may issue a margin call. That will require you to add more funds in your account or sell some of your stocks to reduce the loan amount. It can force you to make decisions you might not want to, such as selling in a down market.
How to Start Using Margin Trading
Margin trading is simple, but you need to be careful. Here’s how you can begin:
- Open free Deamt account online: Before you buy stocks on margin, make sure you open a Demat account. Nowadays, Most brokers offer a margin trading facility. To use it, sign in to your account and activate margin trading app.
- Understand the Terms: Make sure you read the terms & conditions. Know how much margin is required for share trading with your broker, how much leverage you will get, and how long you can hold your pledged shares. Also, look for answers to questions like whether MTF is available on BSE with your broker.
- Keep an Eye on Your Investments: Monitoring your positions closely is critical once you start buying stocks on margin. The stock market can be volatile, and sudden market falls can put you at significant risk since you are dealing with borrowed money.
Conclusion
Margin trading can be a powerful tool, but it is not for everyone. It could be a great way to expand your portfolio and grow your wealth if you’re confident in your stock-picking abilities and can handle the risk. However, always remember that buying stocks on margin comes with added risk, and losses can be increased just as much as gains.
Before you start, ensure you fully understand how margin trading works, how much interest you’ll need to pay, and what happens if the market turns against you. With careful planning, Market margin can help you make the most of your stock market investments, but it’s essential to tread carefully and stay informed.
