If you’re new to investing or want to do more with your money in the stock market, you’ve probably heard of margin trading. It’s when you borrow from your broker to purchase more shares than you can afford to pay for using your own money. It can help you earn larger profits, but it can also lead to bigger losses. This guide will cover what margin trading is, how it operates, the advantages, and the disadvantages.
What is Margin Trading?
Margin trading is a way to buy shares using borrowed money. You open a margin account with your broker, which is different from a regular Demat account. In this margin account, you deposit some money or even offer shares you already own as security (collateral). According to this, your broker lets you take out additional funds in order to purchase additional shares.
For example, if you have ₹10,000 and the broker allows a 50% margin, you can buy shares worth ₹20,000. Your own money covers half, and the other half is borrowed. It is also referred to as MTF trading.
How Margin Trading Works?
To employ margin trading, you need to:
- Open a margin account with your broker
- Pay in some cash or shares as margin
- Begin trading with greater purchasing power
Your broker will lend you the remaining amount of money to purchase additional shares. But don’t forget, this is a loan and you need to pay interest on it.
Also, your broker will monitor your account. If the value of your shares falls too much, your broker can request that you put more money into the account or sell your shares to cover the borrowed money. This is known as a margin call.
Benefits of Margin Trading
The following are some of the major advantages of margin trading:
1. More Buying Power:
You can purchase more shares than your cash permits. This implies that you can earn more profit if the price of the share increases.
2. Use Existing Shares as Collateral:
If you already have shares in your Demat account, you can use them as margin. This means you don’t always need fresh cash to trade.
3. Profit from Short-Term Movements:
Margin trading is best for short-term trades. If you believe a share will rise soon, you can use margin to take advantage of that movement.
4. Faster Returns:
Since you’re investing more through borrowed money, you may earn returns faster if the market goes in your favour.
Risks of Margin Trading
While margin trading can be helpful, it also comes with risks. Here’s what you should be careful about:
1. Bigger Losses: Just as profits get bigger with margin, so do losses. If the share price falls, you may lose more than what you invested.
2. Margin Calls: If your share value dips below a certain level, the broker will request that you deposit more money into your account. If you fail to do so, they will sell your shares.
3. Interest Cost: Interest is charged by the broker on the borrowed funds. If you hold the shares for an extended period, the cost accumulates and diminishes your earnings.
4. Compulsory Sell-Off: If you don’t meet the margin call, your broker has the right to sell your shares without asking you. This can lead to losses.
Who Can Use Margin Trading?
You can use Margin Trading if you have:
- A Demat account
- A margin account with your broker
- Some cash or shares to offer as margin
Also, you must be ready to take the risk. Margin trading is not ideal for complete beginners or those who cannot afford losses.
Simple Tips to Use Margin Trading Wisely
- Start Small: Don’t borrow the full limit. Begin with a small amount and learn how it works.
- Be Ready for Margin Calls: Keep some extra cash handy. If the market goes against you, you’ll need it.
- Use it for Short-Term Trades Only: Since interest adds up, avoid holding margin positions for long.
- Invest in Good Stocks Only: Use margin only for quality shares that you’ve studied well. Avoid risky or new stocks.
Is Margin Trading Allowed in Mutual Funds?
No, mutual funds cannot be purchased using margin trading. This is because mutual fund prices are determined once a day after the closing of the market. They are not exchanged as shares on the stock market. You buy and sell mutual funds directly from mutual fund companies, so brokers can’t offer loans for these.
India’s market regulator, Securities and Exchange Board of India (SEBI), permits margin trading only through registered brokers. Previously, cash alone was permitted as margin, but shares are now also accepted as collateral. Yet, not all shares can be used for margin trading. Only particular shares are approved by SEBI and the stock markets.
Conclusion
Margin trading is a useful tool that allows you to purchase more shares using less money. It can bring you quicker profits when the market does well. It can also cause significant losses when the market turns against you. That’s why it is important to use margin trading carefully and always understand the risks involved. If you are an investor who is interested in experimenting with MTF trading, ensure you already possess a Demat account and trade using funds you are willing to lose.
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