If you come across a stock that you want to buy but don’t have enough funds in your account, you may either wait for additional money, sell existing holdings, or miss the opportunity altogether if none of the options are feasible at that moment. Just like credit cards or buy-now-pay later options used in online shopping, the stock market also offers a similar facility to bridge this gap.
Known as the Margin Trading Facility (MTF), it allows investors to purchase shares by paying only a portion of the total value upfront, while the stockbroker funds the remaining amount. However, the borrowed amount is not free and brokers usually charge interest on the funds used, which is added on top of the principal and must be repaid along with it.
MTF is considered as high-risk option as the chosen may not deliver profits like you expected. Investors should only use if they fully understand the terms and conditions. Here’s a detailed breakdown on how this facility works and what details you must know before opting for it.
What is the margin trading facility?
Margin trading facility is a financial tool that allows investors to buy stocks by paying only a part of the total value, while the broker funds the rest. This provision enables investors to take larger positions in the market even if they do not have the full capital required at the time of purchase.
For example, if you plan to buy shares of a company worth ₹5 lakh but you only have ₹3 lakh in your account. Instead of missing the opportunity, you can use MTF and finance the transaction. In this case, the ₹3 lakh paid by the investor acts as the margin, while the remaining balance of ₹2 lakh will be the margin trade funding provided by the broker.
How does the facility work for buying stocks?
The facility can be used when you identify a stock that you believe could deliver strong short-term returns, for instance, 10% in a month, and you want to invest ₹5 lakh in it but only have ₹2 lakh in your brokerage account. In this case, margin trading allows you to take a larger exposure, but the outcome will depend on market movement, leading to two possible scenarios in terms of profit and loss:
— If the stock gives 10% profit in a month: If you use MTF and buy shares worth ₹5 lakh (assuming you get 10% returns in a month), you will have to pay ₹2 lakh from your own pocket while the broker will fund remaining ₹3 lakh. In this case, let’s assume that broker is offering MTF at 12% annual interest.
After a month, if the stock rises by 10%, the value of your holding increases by ₹50,000, taking the total to ₹5.5 lakh. However, you also need account for the borrowing cost. With an annual interest rate of 12%, the monthly interest comes to 1% of ₹3 lakh, which is ₹3,000.
So after deducting the interest cost, your effective value of holding becomes ₹5.47 lakh, excluding charges, taxes and other applicable costs.
— If the stock falls by 10% in a month: Now let’s assume, the stock did not perform like you expected and the shares of the company fall by 10% in a month. Since you already used MTF to fund the shares, you will have to pay the interest on the borrowed amount.
In this case, the value of your holding will fall by ₹50,000, bringing it down to ₹4.5 lakh. On top of this, you will also be charged one-month interest of 1% on ₹3 lakh that you borrowed from the broker, which is ₹3,000.
So, after accounting for interest, the effective value of your holdings comes to ₹4.47 lakh, excluding brokerage charges and taxes.
Hence, MTF can be rewarding if your plays out as expect, but it also amplifies losses when the market moves against you. The key detail that one should note is that your expected return should comfortably exceed the broker’s interest rate, otherwise, even your stock selection may not translate into profits and can also lead to net losses.