Pros and cons of margins trading facility in India

11 Nov 2024 , 12:56 PM

UNDERSTANDING MARGIN TRADING

When we talk of margin trading, it normally happens at two levels. The first level of margin trading is when you put a margin and take a position that is a multiple of that margin, but only for intraday purposes. Let us understand this further. Most of the low-cost brokers offer leverage ranging from 10 times to 20 times the margin. For instance, if you start with a margin of ₹50,000, a regular broker may allow you intraday margins to the tune of ₹5 lakhs. Remember that this is the total open position you can have at any point of time. It can either be a long position or it can be a short position. For instance, if you have bought 1000 shares of Company X at ₹485 or if you have short sold shares of Company Y of 500 shares of up to ₹950; then in both cases, you have almost exhausted the margins and can only take fresh positions after these are partially or fully closed and margins released. Then what about losses and profits. Look at two scenarios.

• In the long position you have taken above of Company X, the price has gone up from Rs485 to Rs521. You can book the intraday gains and the profit of ₹36,000 will be added to your base margin and now your margin amount will ₹86,000 instead of ₹50,000.
• In the short position, you have taken on Company Y, the price of the stock has also gone up to ₹972. However, since this is a short position, you have a stop loss at ₹972, which got triggered. As a result, the loss of ₹11,000 in the short position will be reduced from your margin account and your margin balance will fall from ₹50,000 to ₹39,000. Accordingly, your ability to take fresh positions also reduces.

These are strict intraday positions and you have to close the position before the end of the trading session. If you don’t close the position, the broker will trigger the closure of position as part of risk management and this will happen about 15 minutes prior to the close of the trade. You need to be wary of that. Normally, it is suggested to always trade intraday with strict stop losses and profit targets.

Quite often, the broker will tell you 10X in margin trading, but they would give you only about 6 times and the 10X is only for cover orders and bracket orders. These orders are the ones which have stop losses and sell targets inbuilt into the trade itself. Is this kind of facility possible in the case of delivery for a few days. Most brokers do not encourage that system. However, there are some brokers that offer up to 3X leverage on delivery subject to the understanding that the position would eventually be squared off by T+5 day. However, this is a service that very few brokers are offering. However, there are a number of brokers offering the margin trading facility (MTF), which is about getting a position funded officially through the NBFC arm of the broker and then paying interest for the number of days the funding is availed.

MARGIN TRADING FACILITY (MTF) ON DELIVERY

Have you ever seen an attractive stock and wished you had more money to buy that stock. Today, if you want to make reasonably good profits, you should be able to take big positions in the market. Unless you do that, profits will be small and limited. It also happens that you are confident about a stock but don’t have the funds. With your limited resources, you buy a small quantity of the stock, and find the stock surging 30% in 4 days. You realize that you have missed a golden opportunity if you had more cash on hand. Now you don’t need cash on hand. All you need is a margin trading facility (MTF) with the broker and you can borrow the money you cannot afford to put yourself.

UNDERSTANDING MODUS OPERANDI OF MTF

The Margin trading facility or the MTF is a special feature offered by most brokers in India. It basically enables and empowers the investors to purchase more stocks than they can afford. Essentially, when you have a high conviction on a stock, now you don’t have to miss out the opportunity just because your funds are falling short. You can just borrow at nominal rates of interest and invest the monies. How is it useful to the investors? Investors can earn high returns by buying stocks. For instance, normally if you can buy X stocks, with margin trading facility (MTF) you can now buy up to 3 to 4 times the original quantity. That means; if the price move is favourable, then you can even magnify the profits.

Under the margin trading facility or MTF, the stockbroker lends money to the customer to fill the gaps in resources. It is like taking a loan and funding, the only difference is that the shares so bought will be pledged to the financier can only be taken possession in demat account after all the dues are fully paid or the position is squared and profit booked. That is why the margin trading facility or MTF is also called a leveraged product as you borrow and invest. In short, when the position is taken under MTF, the funding is automatically routed through the NBFC arm of the broking house. This will ensure that you don’t miss out on opportunities. Remember, risk management is essential here too.

PRACTICAL EXAMPLE TO UNDERSTAND MTF TRADE

In terms of procedure, it is quite simple. You need to open a margin trading facility (MTF) account with your broker. Ensure that the broker is offering that service. The practice is that the broker will only disburse funds into the MTF account, after the due diligence is done. However, you cannot take MTF positions in all stocks since the list is already predefined by SEBI. Let us look at a practical example, after your MTF account is activated.

Assume that a trader has ₹60,000 available and wants to buy shares worth ₹1,50,000. That is perfectly possible through the Margin Trading Facility or MTF offered by your broker. The broker may define at least 30% margin, but in your case, you can pay the full ₹60,000 as margin and get ₹90,000 funded. Alternatively, you can put in ₹50,000 (keep ₹10,000 for MTM needs) and get funding for ₹1,00,000. If you opt for the latter option, the broker is effectively funding you for ₹1 lakh and the interest will be charged on the funded amount for the period for which the position is open.

However, if the market falls, the broker may ask the customer to bring in additional margins. Alternatively, they can even ask the customer to close part of the position, even if be at a loss. If the customer does not adhere to either of the instructions, the broker can take the initiative and close the position after giving due notice to the customer. The broker can charge the loss and the interest for the period to the customer. Hence MTM is something you must track very closely.

CHARACTERISTICS OF MARGIN TRADING FACILITY IN INDIA

Let us now highlight some of the key characteristics of the margin trading facility in India. Here are a few points to consider.

• MTF offers investors the chance to leverage their position in the stock market wherein either cash or stocks can be offered as collateral.
• SEBI has given an MTF list and no broker can allow trading in MTF in any stock that is outside that list. It is a breach of regulations.
• MTF can only be offered by SEBI authorized and recognized brokers and even in such cases, it has to be routed through the NBFC arm of the broker.
• Margins can vary between 3X and 5X depending on the internal policies of the broker, policies of the bank, quality of stocks, volatility in the market etc.
• You pay interest on the open position to the extent of the number of days you carry forward. The outer limit is defined by the broker. It can vary typically between 180 days and 270 days, which is normally the outer limit for which the funding is provided.

Two things investors must remember about MTF. Leverage can work both ways. It can magnify your profits and also your losses. Secondly, this sort of trade works best when you keep churning in and out of the stock, so the interest paid is minimal. That logically means that your focus must be on momentums stocks.

PROS AND CONS OF MARGIN TRADING

Obviously, margin trading is not a one way street. Here are some major advantages of margin trading facility.

• It allows you to take positions in the stock, you normally cannot afford.
• It ensures you don’t miss out on high conviction opportunities.
• Being a leveraged product, it can magnify the profits of the trade.
• It works well in high momentum stocks to boost profits in the short run.
• It works very well in bull markets when gains get amplified by leverage better.
• Rates of funding are low as it is back-to-back funding.

However. it is not roses all the way. Let us also look at some of the downside risk of MTF trading or margin trading

• Leverage works both ways. Just as leverage can magnify your profits, it can also magnify your losses on volatile days
• Be prepared for MTM provisions. You are not done with taking the position. If the margin goes below a threshold, you have to bring in more margins or close positions.
• At times, the broker may close the position in MTF due to high risk. That can result in fairly large losses for the client.

Finally, there is also the regulatory risk of margins, additional special margins, risk margins, limits etc, which can distort the price, even though your view may be right.