It is important to learn how a margin trading facility (MTF) works, especially for those who are about to open a demat account. Quite a few brokers in India provide MTF to their clients which allows them to buy financial instruments by paying only a portion of the transaction value. The remaining portion of the transaction value is provided by brokers.
Let us say that you open a demat account. You notice that a certain stock is available at ₹2,000. You think its price will go up to ₹2,300 and you want to buy 40 shares of this company, which means you need ₹80,000. However, you have only ₹30,000 in your trading account.
If your broker provides a margin trading facility, you can take a loan of ₹50,000 from him and buy 40 shares. However, you will need to pay interest on the funds you borrow from your broker.
That said, there is an element of risk for a broker in this facility. What if an investor does not pay back the money borrowed from a broker for using an MTF? Hence, a broker keeps the securities bought using an MTF as collateral until the investor pays back the borrowed amount.
How can a margin trading facility help you generate a return?
Let us go back to the example we took earlier. You have bought 40 shares at the price of ₹2,000 each, thereby investing ₹80,000. Suppose the price of this stock reaches ₹2,300, as you had predicted. Now, the value of your investment is ₹92,000 (40 * 2,300). However, your own capital was only ₹30,000 because you had borrowed the remaining ₹50,000 from your broker.
Therefore, you have earned a profit of ₹12,000 (92, 000 – 80,000) by investing ₹30,000. Hence, you have generated a return of 40% on your original capital! Now, you can see how MTF can amplify your profits.
However, MTF is a double-edged sword. Just as it can amplify your purchasing power, it can also multiply your losses. Hence, you need to be careful. Suppose, instead of increasing to ₹2,300, the stock price falls to ₹1,700.
Now, you will incur a loss of ₹300 on 40 shares, meaning a total loss of ₹12,000 on a capital of ₹30,000, which means a 40% loss!
But, the story does not end here. Suppose, you buy a stock on MTF and its price starts falling drastically, what will your broker do? After all, you keep the securities you buy using an MTF with the broker as collateral. When the share price falls, the value of the collateral falls, too.
Hence, your broker may tell you to deposit more funds by issuing a “margin call.” If you fail to deposit additional funds, your broker can sell the shares you had kept with him as collateral.
About to open a demat account? How to select a broker for an MTF?
If you want to use an MTF, you need to select a broker carefully. Hence, you should read all the reviews and ratings available on online channels before signing up with a broker. You can even ask fellow traders for their feedback if they use an MTF on a regular basis.
In the Indian stock market, several brokers allow you to trade around 1,000 listed stocks with an MTF. Before you select a broker, you should check for how many stocks they provide a margin trading facility.
Needless to say, always go for a reputed broker. For example, Bajaj Broking provides MTF to several investors and it is a reliable brand in this space. Bajaj Broking provides an MTF that allows you to take stock market positions worth up to 4 times more than your purchasing power. That said, there are many reliable brokers in the Indian stock market. However, you need to do proper research before signing up with them to use their MTF.
