Margin Trading Facility (MTF) in India has indeed made its way into the mainstream with good popularity in its answer for allowing traders to increase their positions in the market using borrowed money. Whether you are dealing with MTF stocks or exploring MTF trading, it is of utmost importance to know the advantages and drawbacks offered. This article sets out the five biggest pros and cons of margin trading in India so that you can make an informed decision.
What is margin trading?
The Margin Trading Facility (MTF) enables investors to buy shares by putting up an initial payment, usually about 25% of the purchase money, the remainder being funded by the broker. The facility allows traders to leverage their positions so that they can increase their profits. But MTF trading has its risks too, and it is therefore vital for investors to weigh both the advantages and disadvantages of MTF.
Top 5 Reasons to Go For Margin Trading in India
1. Magnified Returns
One of the biggest cherries on the cake for MTF trading is the ability to maximize your returns. Since MTF trading is about obtaining funds from your broker, even a little price rise in MTF stocks can translate into big bucks. As an example, assume you enter MTF with four times leverage on a stock price rising by 5%; this will amount to an effective return of 20%, ignoring brokerage and charged interest.
2. Wider Market Exposure
Margin trading lets investors build larger positions without committing large capital. This structure means traders can reduce their risks by taking exposure on several stocks simultaneously, thus enhancing their market exposure.
3. Short Term Trading Opportunities
MTF trading provides an avenue for short-term traders to take advantage of market volatility. By borrowing money, traders can profit from short-term price fluctuations, thereby increasing their chances of profitable trades.
4. Optimize Liquidity
MTF trading enables investors to stay liquid by optimizing the use of funds. Traders can strategically invest on several MTF stocks while keeping cash for other opportunities instead of placing all their capital into just one transaction.
5. Leverage in Volatile Markets
Margin trading can come in handy during volatile markets. The traders can take leverage in the rising markets and falling markets. Experienced traders understand the market trends and would have maximized profits by entering and exiting their positions at the right time.
Here are the top 5 cons of Margin Trading in India
1. Increased Exposure to Risk
Leverage may amplify returns for traders in margin trading, but it also raises the risk of losses. For an MTF stock that declines in price, traders could incur losses that heavily exceed their initial investment. The high-risk nature of margin trading makes it an inappropriate form of speculation for an inexperienced investor.
2. Interest on Borrowed Money
In executing margin trading, traders are borrowing money from the broker, which incurs interest payment. In a situation where such trade does not give much return, the interest being paid could greatly diminish profits or, sometimes, incur losses.
3. Margin Calls and Forced Liquidation
When the stock price moves lower than the trader initiated position, brokers issue margin calls requesting the investor deposit more capital onto that position. If the margin calls are not met, the broker liquidates the MTF stocks at undesirable prices, often leading to heavy losses for investors.
4. Emotional Trading and Over Trading
Borrowing money to trade can lead to impulsive trading decisions. For the sake of making more profit, many traders overtrade, increasing their risk exposure. Emotional trades create bad investment decisions that sometimes result in unforeseen losses.
5. Limited Holding Period for MTF Stocks
Most brokers impose a time frame for the holding period of MTF stocks ranging from a few days to a month. If traders fail to close their positions before the given time frame, brokers will, without notice, square off the trade, which could lead to possible losses in case the market reverses.
Conclusion
The Margin Trading Facility (MTF) can be a very powerful tool for traders wishing to maximise returns, provided the risks involved are well understood. MTF trading mechanisms, while permitting maximized profit, higher market exposure, and greater opportunities within a short frame of time, pose further risk aversion, the cost of interest, and forced liquidation opportunities.
