Stock market investing can be an exciting proposition that could help you build wealth for various goals. However, you need capital to seize them. This is where the margin trading facility (MTF) can rescue you. Through MTF, you can buy stocks by paying a fraction of the total value of the trade while borrowing the remaining amount from your broker. It’s a loan that helps amplify your buying power to maximise potential gains. Read on to learn how MTF works in the stock markets.
What is a Margin Trading Facility?
A margin trading facility or MTF is a feature stock brokers offer that enables you to buy shares by paying a small margin upfront. The broker provides the remaining funds to complete the trade. In other words, it acts as a loan for stock purchases, with your stocks being held as collateral until you repay the loan.
Let’s understand MTF with an example. Suppose you want to buy shares worth ₹1 lakh but have only ₹30,000 in your account. Under the MTF facility, you can borrow the remaining ₹70,000 through MTF.
How Does MTF Work?
Now that you know what a margin trading facility is, let’s see how it works. Though specifics may differ across different brokers and stocks app, here’s how MTF generally works:
Open a Demat and Trading Account With Your Broker
To use the MTF facility, you need to open a demat and trading account with a broker offering this facility. Today, almost all brokers, both discount and full-services, offer this facility.
Initial Margin Requirement
Before availing of the MTF facility, you need to pay your broker a minimum amount known as the initial margin. The initial margin requirement may differ across brokers and financial instruments. It is generally high for riskier instruments such as derivatives. For instance, if your total trade value is ₹1 lakh and the initial margin requirement is 25%, you need to deposit ₹25,000 while your broker funds the remaining ₹75,000.
Identify the Financial Instrument You Want to Buy and Place the Trade
Next, choose the financial instrument and quantity you want to buy through MTF. Pay the initial margin, borrow the remaining amount from your broker and place the trade. Be mindful of the interest you need to pay on the borrowed funds. A high interest rate can eat into your profits. Also, make sure to return the borrowed money with interest as per the applicable interest rate on time.
Today, almost all stock brokers have a dedicated app through which you can access a margin trading facility.
Advantages of MTF
Here are some key benefits that MTF brings to the table:
Increased Buying Power
MTF allows you to purchase more shares than your available capital. MTF can help you leverage market opportunities and potentially earn more returns on your investments.
Opportunity to Earn More Returns
As MTF enables you to trade with borrowed funds, even a tiny rise in share price can help you generate significant profits. For instance, if you buy shares worth ₹1 lakh by paying an initial margin of ₹25,000, a 10% rise in stock prices can take your profit to ₹10,000. Without MTF, you can buy shares worth only ₹25,000, and your earnings would be limited to ₹2500. But, it also includes high risk.
Helps You Capitalise on Short-term Price Movements
MTF can help you capitalise on short-term price movements, without committing a considerable sum upfront. This can come to your aid in situations when you don’t have a large investible surplus.
Risks Associated With MTF
While MTF does offer the benefits mentioned above, it also comes with significant risks. Here are some potential risks you need to consider before availing MTF:
Risk of Losses
Though MTF can amplify your buying power, it can also potentially magnify your losses. If the stock price doesn’t go up as anticipated and falls, you can suffer higher losses because of trading on borrowed funds.
Interest Costs
Brokers charge interest on the borrowed amount since it’s a loan. This can reduce your overall returns. If you hold the MTF position long, the interest cost may outweigh the profits.
Possibility of Margin Calls
If the value of the pledged shares falls below a certain threshold, your broker can issue a margin call. You need to add more funds to your account when you receive a margin call. Inability to meet the margin call gives your broker the right to sell your shares to recover the loan amount.
Essential Things to Keep in Mind
In case you want to avail of the MTF facility, here are some tips to keep in mind:
Understand Your Risk Tolerance
MTF involves high risk. You can opt for this facility if you have a high-risk tolerance and understand how leverage works.
Choose the Right Broker
Before availing of MTF, compare interest rates, margin requirements, and terms offered by different brokers before selecting one. Ensure diligence and don’t choose in a hurry.
Keep an eye on Your Positions Regularly
Keep a close eye on your MTF positions and overall market conditions to avoid unexpected and large losses.
Avoid Over-Borrowing
Borrowing too much under MTF can be risky. It’s vital to use only MTF to the extent you can manage losses.
Be Mindful of Margin Calls
Ensure you maintain sufficient collateral and cash to meet margin calls if needed.
Conclusion
Understanding the workings of the marginal trading facility and its various aspects can help you use it to your benefit and invest more in markets. That said, you need to use it with prudence to ensure you stay clear of its pitfalls.
HDFC SKY offers one of the best MTF rates in the market, through which you can boost your buying power up to 4X. For the first 30 days, you don’t need to pay any interest rate on MTF availed through HDFC SKY. open free demat account with HDFC SKY and avail of the MTF today to boost profits.
