What is the Role that Margin Trading plays in leveraging investments?

Listen to our Podcast: Grow your wealth and keep it secure.

0:00 / 0:00

Synopsis:

A margin trading facility helps investors take a larger position by helping them borrow funds from their stockbroker and purchase securities that their funds alone will not allow them to. The stockbroker charges a nominal interest rate on this borrowed amount that needs to be paid yearly by the investor. Here is everything you need to know about MTF trading.

Understanding Margin Trading

Margin trading is a leveraged investing method by which investors can borrow money from a broker to buy stocks. The main aim of margin trading is to provide the investor with the provision to purchase more than their current funds will let them. The margin trading facility helps investors take a larger position and can also eventually lead to possible gains for them. 

The Margin Trading or MTF account is a separate account that an investor needs to open with their DP or broker. The MTF account needs to hold a specified minimum balance, which the broker or DP declares. This minimum balance needs to be maintained, and is called ‘minimum margin’. The operations of such an account are predefined by both SEBI and the stock exchanges. 

When the time to initiate a trade comes, the investor will have to deposit a percentage of the total trade value while the remaining amount is funded by the DP or broker. On the amount funded by the broker, a minimal, usually affordable interest rate is charged to the investor. 

Certain features are involved in margin trading. These margin trading basics are listed below are some of them:

  • Authorised Brokers: Not all brokers are allowed to provide the margin trading facility to investors. Only brokers who are registered and licensed by SEBI can offer this provision to investors.

  • Collateral: There are two types of collateral that investors can use in margin trading. This includes either cash or securities in the investor’s portfolio. An investor can leverage either to borrow money from the broker

  • Carry Forward: Margin trading offers its investors the provision to carry forward their position from the trading day (T) to several days which is determined by the broker (N). N here can vary from one broker to another.

  • Margin Increase: When the market is bullish and stocks are being appreciated, then an investor’s margin that has been put down as collateral also increases. As a result of this, investors can buy more securities on the margin if they want to.    

Benefits of Margin Trading

There are several benefits of margin trading. Below is a list of some of them:

  1. Higher Returns

    With a leveraged investing facility like MTF, investors can improve their return percentage on the capital provided with the least amount of capital allocation.

  2. Betting on Bigger Trades

    Margin trading helps investors carry out larger trades that are above and out of an investor's budget keeping their available funds in mind. This leverage investing facility provides up to 4x leverage value. This limit however will vary from asset type and trade value to another.

  3. SEBI Monitored

    SEBI monitors the brokers that can provide the margin trading facility to investors, and these usually include corporate brokers. Even the securities that are allowed under the margin trading facility are determined by SEBI and other exchanges.

  4. Using Stocks or Security as Leverage:

    Apart from using cash as leverage, MTF also allows investors to utilize the existing securities in their portfolio and leverage it or use it as collateral as well.

  5. Safety

    Since the brokers providing MTF and the securities listed under MTF are monitored by SEBI, this leverage investment facility is safer than a few other investment options. SEBI ensures and continuously amends the rules to provide better provisions and security to traders and investors.

  6. Several approved MTF scripts

    Many brokers who are authorized to provide MTF to investors also hold with them several MTF scripts that traders and investors can choose from. These scripts are approved and are safe to choose from.

  7. Low-Interest Rates

    A majority of the brokers that provide MTF offer a nominal interest rate for investors to borrow on. This helps investors buy bigger stocks, while not losing money on the payout of the borrowed amount from the broker.

Risks Associated with Margin Trading

Where are benefits associated with margin trading, there are certain risks that the leverage investment facility also poses.  Below is a list of some of them.

  1. Higher gains, but higher losses:

    There is no doubt that margin trading helps amplify gains. However, the same also holds in case of losses. Suppose the value of the security or securities bought on margin by the investor declines rapidly. In that case, the investor or trader will end up owing their initial investment and will have to top that off with additional capital to the broker.

  2. In case of high-interest rates:

    Though most lenders or brokers offer a nominal interest rate in MTF trading, certain corporate lenders might charge higher interest rates. This is why investors must research before selecting the broker they want to go with.

  3. Margin Call:

    A margin call is a requirement that the broker presents the investor with. This requires that the trader or investor deposit additional funds into their margin account due to the fall in the value of the securities being held in it. This is an issue that might end up keeping investors on edge if the market is volatile.

  4. Forced Liquidation:

    Forced liquidation of the MTF account me occur if (a) the investor is not able to deposit the additional equity or (b) if the value of the MTF account drops rapidly breaching margin requirements. With the forced liquidation, investors will have to sell the securities that were purchased on margin which may lead to losses.

Margin Requirements and Regulations

To protect the interest of the traders and bring transparency to the MTF process, SEBI has established and implemented new rules. Below is a list:

  • Initial Margin Requirement (Cash):

The initial margin requirement when it comes to the cash segment is as follows:

  • On the day of the trade (T day), a minimum of 20% of the margin is required for margin reporting

  • On the next day after the trading day, or  T + 1 day, any additional margin that needs to be paid needs to be done by T + 2 days.

  • Initial Margin Requirement (Share Selling):

The initial margin requirement for selling shares is as follows:

  • A minimum initial margin of 20% is required while selling shares

  • The broker can also do an early pay-in to avoid the initial margin

  • No penalty on short margin is applicable

  • Share Pledging:

  • Initially, if an investor had to pledge shares to obtain a margin, they had to transfer the shares to the broker’s account or give the broker Power of Attorney

  • Now, the shares remain in the investor’s demat account. The limit that is placed on the shares that are given as collateral will only apply to the shares that are provided as the margin under the Margin Pledge Mechanism

  • An upfront margin needs to be maintained before the trade begins, otherwise a penalty will be imposed on the trader.

  • BTST or Buy Today, Sell Tomorrow:

For BTST trades, an upfront margin is necessary on both the buy and sell elements.

Strategies for Effective Margin Trading

When it comes to some of the margin trading basics, participating in a leveraged investing facility like MTF needs certain strategies in place to make the process effective. Below is a list of some of them: 

  • Risk appetite and investment goals:

Investors need to figure out how much risk they can take in MTF. This will further help them figure out how much they can borrow with MTF. With the risk appetite sorted, investors should have clear trading goals in mind. 

  • Educate yourself:

Investors need to recognise the importance of starting small. With zero-margin trading experience, traders can face heavy losses. Begin with a small amount and examine the results. Then gradually increase the amount. It is also crucial that investors read more about technical and fundamental indicators and risk management techniques to navigate the MTF waters better.

  • Risk Management:

Margin trading can be risky because of the inherent volatility of the market. This is why investors need to diversify their investments across various securities. This helps offset any potential losses with potential gains from other investments. 

  • Research:

Investors should never go into trading without conducting their research. This holds specifically for the securities they are looking to buy through margin. From company fundaments and historical prices to the current market trends everything needs to be analysed before buying a share.

  • Regular Monitoring of Trades:

Investors need to stay on top of their investments and monitor them regularly. Because of the real-time fluctuations in the stock market, the value of a trader’s investments can change rapidly. If needed, investors can also make real-time adjustments when regularly monitoring their investments to limit losses or lock in profits too.

  • Don’t over-leverage:

Where on the one hand MTF offers better profits, it can also lead to higher losses. Thus, over-leveraging is discouraged as a part of MTF. If investors end up borrowing more than their means, they could face significant losses. 

Comparing Margin Trading with Traditional Investing

There are significant differences between margin trading and traditional investing. Below is a list of some of them.

Features

Margin Trading

Traditional Investing 

Leverage

Using leverage to help investors buy more than their available cash will let them

No leverages are used. Investors can only invest according to their affordability 

Risk

Riskier and has the potential for greater losses in a volatile market, especially with the possibility of margin calls 

Less risky as investors use only their funds to invest. As a result, the risk of margin calls does not exist. 

Return

Chances of higher returns because of a larger position. 

Returns dependent on the money invested by the trader

Interest

Semi-annual or annual interest needs to be paid to the lender, which can vary from one lender to another

No interest as no amount is borrowed. 

Account

Requires an MTF account with the lender and has to maintain a specified minimum balance in it. 

Can be conducted through the normal trading account. No special requirements. 

Margin Trading Tips and Best Practices

When investors enter the MTF trading world, having a few tricks up one’s sleeve to make the best out of the experience. Below is a list of some of the best tips and practices that investors can partake in:

  • Research Interest rates:

Since many stockbrokers provide MTF, it is important to pick the ones offering the best and most affordable interest rates. This interest has to be paid annually to your stockbroker, and knowing the rate before you begin your MTF journey is important to make an informed decision. 

  • Use Stop Loss Orders:

With a stop-loss order in place, investors can avoid losses and margin calls. The stop-loss order helps the stockbroker automatically sell an investor’s shares when they fall below a particular price level. 

  • Have a backup fund:

Investors should never invest all they have in MTF. Investors must have a backup fund to fall back on in case their MTF investment suffers losses. 

  • Learn the MTF Terms:

Before investors decide to opt for MTF, they should read all the terms and conditions associated with the facility. This will help them stay informed and on top of their investment potential.  

  • Avoid Margin Calls:

The margin call is considered a warning issued by the stockbroker to make the investor add funds to the MTF account to cover losses. Investors might also need to sell stocks to offset the losses. Every stock an investor buys on margin holds a price level that triggers this margin call. 

Conclusion

Margin trading is a leveraged investing method that helps investors buy securities worth more than the funds they hold by borrowing funds from the stockbroker. The stockbroker charges a nominal rate of interest, yearly, on this borrowed amount from the investor. However, investors need to be aware that since the stock market is volatile, MTF trading can lead to both significant gains and losses. This is why investors need to look at every aspect of buying a security on margin before actually purchasing to avoid any potential losses. Research and gaining more knowledge about MTF trading is crucial for investors to make the best of their investment.

Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.

This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.

For All Disclaimers Click Here: https://bit.ly/3Tcsfuc

Share this article: 

Frequently Asked Questions

What is margin trading and how does it work?

Answer Field

Margin trading is a leveraged investing method by which investors can borrow money from a broker to buy stocks. The main aim of margin trading is to provide the investor with the provision to purchase more than their current funds will let them.

When the time to initiate a trade comes, the investor will have to deposit a percentage of the total trade value in their MTF account, while the remaining amount is funded by the DP or broker. On the amount funded by the broker, a minimal, usually affordable interest rate is charged to the investor.

How does margin trading increase investment leverage?

Answer Field

Since investors, with the help of margin trading, can invest in larger volumes of stock with a smaller amount, the MTF trading method ends up increasing the investment leverage.

What are the benefits of margin trading?

Answer Field

The benefits of margin trading are listed below:

  • Investors gain a higher position with less investment

  • Investors can improve their return percentage on the capital provided with the least amount of capital allocation

  • Margin trading helps investors carry out larger trades that are above and out of an investor's budget keeping their available funds in mind.

  • Apart from using cash as leverage, MTF also allows investors to utilize the existing securities in their portfolio and leverage it or use it as collateral as well. 

  • Since the brokers providing MTF and the securities listed under MTF are monitored by SEBI, this leverage investment facility is safer than a few other investment options.

What risks should investors consider with margin trading?

Answer Field

Where there are benefits, there are also certain risks that investing through MTF trading can hold

  • There is no doubt that margin trading helps amplify gains. However, the same also holds in case of losses. The potential for both higher gains and higher losses is there in MTF trading.

  • Though most lenders or brokers offer a nominal interest rate in MTF trading, certain corporate lenders might charge higher interest rates. 

  • A margin call requires that the trader or investor deposit additional funds into their margin account due to the fall in the value of the securities being held in it. 

  • Forced liquidation of the MTF account me occur if (a) the investor is not able to deposit the additional equity or (b) if the value of the MTF account drops rapidly breaching margin requirements. With the forced liquidation, investors will have to sell the securities that were purchased on margin which may lead to losses.

How can investors manage risks associated with margin trading?

Answer Field

By keeping a few practices in mind, investors can successfully manage risks associated with MTF trading. Some of them are listed below:

  • By using a stop-loss order, investors can avoid losses and margin calls. The stop-loss order helps the stockbroker automatically sell an investor’s shares when they fall below a particular price level. 

  • Investors also need to stop themselves from investing all of their funds in MTF. Having a backup fund to fall back on in case their MTF investment suffers losses is crucial. 

  • Investors should be aware of all the terms and conditions associated with MTF trading to truly understand all the aspects of this facility and avoid potential risks and losses.

What are the margin requirements and regulations for margin trading?

Answer Field

The margin requirements and regulations for margin trading are listed below:

  • Initial Margin Requirement (Cash):

The initial margin requirement when it comes to the cash segment is as follows:

  • On the day of the trade (T day), a minimum of 20% of the margin is required for margin reporting

  • On the next day after the trading day, or  T + 1 day, any additional margin that needs to be paid needs to be done by T + 2 days.

 

  • Initial Margin Requirement (Share Selling):

The initial margin requirement for selling shares is as follows:

  • A minimum initial margin of 20% is required while selling shares

  • The broker can also do an early pay-in to avoid the initial margin

 

  • No penalty on short margin is applicable

  • Share Pledging:

  • Initially, if an investor had to pledge shares to obtain a margin, they had to transfer the shares to the broker’s account or give the broker Power of Attorney

  • Now, the shares remain in the investor’s demat account. The limit that is placed on the shares that are given as collateral will only apply to the shares that are provided as the margin under the Margin Pledge Mechanism

 

  • An upfront margin needs to be maintained before the trade begins, otherwise a penalty will be imposed on the trader.

  • BTST or Buy Today, Sell Tomorrow:

For BTST trades, an upfront margin is necessary on both the buy and sell elements. 

 

How does margin trading differ from traditional cash trading?

Answer Field

There are quite a few differences between margin trading and traditional cash trading. Some of them include:

  1. MTF uses leverage to help investors buy more than their available cash will let them while in cash trading investors can only invest with their funds

  2. MTF is riskier with the possibility for greater losses in a volatile market while cash trading is less risky

  3. Higher returns because of bigger positions while in traditional investing, returns are dependent on the investment

  4. Interest in MTF is paid semi-annually/annually to the broker while there is no interest in traditional trading

No Result Found

Read More Blogs

Our Secure Trading Platforms

Level up your stock market experience: Download the Bajaj Broking App for effortless investing and trading

Bajaj Broking App Download

7.5 Lacs+ Users

icon-with-text

4.3+ App Rating

icon-with-text

4 Languages

icon-with-text

₹4300 Cr MTF Book

icon-with-text