Margin trading or margin trading facility (MTF) is one of the most commonly used terms in the stock market. But, what is the meaning of margin trading? MTF trading or margin trading is a facility which stockbrokers provide to their clients.
Using margin trading, investors can borrow money from their broker to purchase stocks. Effectively speaking, MTF trading allows investors to buy more shares than they would be able to normally. Now, the question is: how margin trading works?
How does margin trading work?
To start with margin trading, the first thing you need to do is get a margin account opened with a broker. A margin account is different from a cash account. A cash account allows you to trade with the money you have in your account. However, a margin account allows you to trade with the money you borrow from your broker.
Let us take an example to understand how margin trading works. Suppose you want to buy 100 shares of a company priced at Rs. 10 each. To do so, you need Rs. 1,000. But what if you do not have Rs. 1000. This is where margin trading or MTF trading helps you.
Suppose you have Rs. 500. You can use margin trading to borrow the remaining Rs. 500 from your broker. Now, let us assume that this stock price rises to Rs. 12 each. The total value of 100 shares is Rs. 1,200 now.
By selling these shares, you can earn a profit of Rs. 200. That said, you will have to pay interest to your broker for lending you Rs. 500.
In India, most brokers provide margin only for intraday trading. So, if you expect the price of a stock to rise, you can buy it using MTF trading. However, there is an element of risk, too. If the price of a stock falls, you will incur losses. Moreover, you will have to pay the money you borrowed from your broker along with the interest.
Meanwhile, there are brokers, which provide the margin trading facility even to those traders who want to hold their positions for longer than a day.
If you are keen to do margin trading, you should ask your broker everything about it so that there is no confusion later.
Advantages of margin trading
Margin trading increases your purchasing power by lending you money to buy more shares than your funds allow. If there is indeed a profit-making opportunity, margin trading will help you make more money than you would have made otherwise.
Margin trading also allows you to buy shares against shares you already have in your demat account. In this case, you provide shares in your demat account as collateral. So, if you already have shares in your demat account and you think that the price of a certain stock is going to increase, you can avail of the MTF trading facility.
Risks of margin trading
Margin trading works as long as your expectations about a stock’s price are correct. However, if a stock’s price starts going in the opposite direction, margin trading will amplify your losses. Suppose you bought a share on margin, thinking that its price will increase.
But, its price ended up decreasing. In that case, you will first earn a loss on the stock. Second, you will have to pay interest to your broker, which will increase your losses.
Conclusion
Having learnt the meaning of margin trading, it is important to acknowledge that margin trading is ideally meant for experienced traders. It can only help those traders who can assess stock market movements correctly.
If you have just begun to trade, you may find it difficult to gauge the direction of the stock market. Therefore, you should be careful while availing this facility. On the other hand, if you are an experienced trader, you can use margin trading after doing thorough research and analysis.
As margin trading allows people to trade on borrowed capital, there is a tendency to get carried away. Therefore, before going for margin trading, always remember the golden rule of trading. You should only take a position if you can bear the maximum loss that it can cause you without losing your sleep.
