Margin trading refers to the practice of buying stocks by borrowing funds from a broker by putting your money as 'margin' or collateral. What does this mean?
Suppose you have a demat and trading account with Chola Securities and your total holding in the account is Rs 5 lacs. If all your holdings or stocks are part of the MTF stock list, then you can get a margin of 70%; i.e., for a holding of Rs 5 lacs, you can get a leverage of Rs 3.5 lacs. This implies that you can buy additional stocks of Rs 3.5 lacs that you can borrow from Chola securities.
Margin trade funding helps you to capitalise on trade positions and with the borrowed funds, you can take a larger position with minimum cash.
What can you do with this additional margin?
Imagine you want to invest in Company A.
But currently you have only Rs 50,000 to invest and with your holding, you can get a margin of Rs 4 lacs.
Chola Securities Margin Requirement for Company A: 50%
Total Purchase Power: With a 50% margin, you can borrow an additional ₹50,000. This method gives you a total of ₹100,000 to invest.
With this additional Rs 50,000, you can borrow it at an interest rate of 0.04% per day, which is equal to Rs 20 per day.
Scenario 1—Stock price rises:
You use ₹100,000 to buy shares. If the stock’s value increases by 20% (to ₹120,000), your profit is ₹20,000. Since you only invested ₹50,000 of your money, your return on investment is 40% (excluding broking fees and interest). If you held the stocks for 10 days, then the total interest for the 10 days would be Rs 20×10 = Rs 200. Scenario 2 – Stock Price Falls:
If the stock’s value drops by 20% (to ₹80,000), your loss is ₹20,000. Here, you would have lost 40% of your money. If the loss continues or reaches a critical level, your broker might issue a margin call, requiring you to deposit more funds or liquidate part of your position to cover it. If you held the stocks for 5 days, then the total interest for the 5 days would be Rs 20×5=Rs 100.
What is a must for accessing MTF?
To use MTF, your account must have DDPI (Demat Debit and Pledge Instruction) activated. DDPI is an authorisation that allows the broker to debit stocks from the client’s demat account and deliver them to the exchange. Once the client submits the DDPI, they can sell shares without needing to enter the CDSL T-PIN and OTP.
It is needed in case your collateral levels go down, yet you still need to continue with your margin position; then you may need to sell additional stocks from your existing holdings to keep that position.
DDPI also protects the client, as it puts the limit for debiting shares from your account in case you place a sell trade.
Margin trade funding is a great choice for traders, as it allows you to take large positions. But it comes with both significant advantages and disadvantages.
Advantages
Amplified Gains:
By using borrowed funds, you can control a larger position than your available cash, potentially increasing your returns if the trade goes in your favour.
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Increased Buying Power:
Margin funding allows you to invest in more shares or diversify your portfolio without having to fully liquidate other investments.
Opportunities for Strategic Flexibility:
Investors can take advantage of short-term market movements or capture additional investment opportunities that might otherwise be inaccessible with only available capital.
Disadvantages
Magnified Losses:
Losses can also significantly increase, just as gains do. A small adverse price movement can lead to a substantial loss relative to your initial investment.
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Margin Calls:
If the market moves against your position, brokers may issue a margin call, requiring you to deposit additional funds to maintain the position or risk forced liquidation of your assets at unfavourable prices.
Interest and Fees:
Borrowed funds come at a cost. Interest on the margin loan and associated fees can reduce your overall profit or increase your losses.Higher Risk Exposure:
The use of leverage increases the overall risk of your portfolio, which requires diligent risk management and careful monitoring of market conditions.