Deep Dive into Margin Trading Facility

What if you want to buy a stock that you can’t afford?

If you have observed markets during COVID times or more recent times like the Russia-Ukraine War, what are your observations? Markets are pretty volatile, aren't they? But this volatility brings an opportunity to buy your favourite stocks at discounts, isn't it? That is what Warren Buffet quotes as "value investing." But what happens if you are getting your favourite stocks at deep discounts but you are short of funds? Considering this opportunity is a rare one, what should you do? Well, here’s what you can do:

SEBI has introduced an excellent mechanism which can address your concerns. This mechanism is called Margin Trading Facility.

To put it simply, margin trading is when an investor borrows money to buy stocks. The way it usually works is that your broker loans you money and charges interest on that. As a result, you have greater purchasing power for stocks than you would have with only cash. In this case, money and shares lying in your account can work as a margin.

So that is very convenient. But what is the catch?

Well, the problem is that your broker isn't investing with you and isn't sharing any of the risks. He just provides you with a loan. You will be responsible for repaying the loan regardless of how the stock performs. As per SEBI regulations, only authorised brokers can offer the margin trading facility.

How does buying stocks on margin work?

To use the margin trading facility, you must have a margin account with the broker. A margin loan is secured against all securities in your margin account (for example, stocks and bonds). The margin charged on your investments is specified by SEBI and exchanges at regular intervals. You have to maintain the required margin in your MTF account till you hold the position. If you fail to do so, your broker can square off the position.

Let's understand how MTF can generate better profits compared to conventional Investing.

When Russia attacked Ukraine on February 24, 2022, markets all around the world plummeted. The Nifty opened with a drop of around 800 points. This was an excellent opportunity for all value investors, as major stocks had suffered significant price declines and were again available at attractive prices. Even Reliance had lost more than 5% of its value. Let me explain how MTF can help you seize this opportunity.

Consider the following two possibilities: Assume you had one lakh rupees in your account and purchased Reliance on that particular day. On the 24th of February 2022, you could buy roughly 44 shares of Reliance because it was trading for around ₹2250.

What are your returns if you have ₹20,000 worth of shares? What will your MTF funding cost be? You can use these shares and ₹1 lakh cash as a margin to avail MTF facility. If we consider a margin of 25%, a margin of ₹1.2 lakhs may be used to purchase Reliance shares valued at ₹4.8 lakhs. Any Broker may be able to cover the remaining ₹3.6 lakhs. So, with ₹4.8 lakhs, you can now buy 213 shares on that specific day.

Let's see what happens if you retain this position for the following 15 days.

Scenario 1: Reliance was quoting about ₹ 2399 on March 11th. Your profits would be about ₹ 6556 or 6.5 percent if you close your position now.

Scenario 2: It will be more exciting to observe how your MTF position evolves.

Let's see what happens if you retain this position for the following 15 days.

Number of Shares	213
Buy Value	₹ 4,80,000
Sell Value	₹ 5,10,987
Profits	₹ 31737
Returns	6.6%
Margin Amount	₹ 1,20,000
Funding Amount	₹ 3,60,000
Interest on MTF	₹ 612
Net Returns	₹ 31125 or 6.48%

So, if you compare the two situations, you'll see that the second one with MTF yields over 5X the profits of the first one, despite the fact that both have the same amount of money.

SEBI Regulations regarding Margin Trading

Margin trading was only authorised with cash initially, and no shares could be used as collateral. The Securities and Exchange Board of India (SEBI) has eased this requirement in 2017 by enabling investors to open margin trading positions by leveraging shares as collateral. This move is considered a breakthrough for the success of MTF.

Trading on margin appears to be beneficial due to the following advantages:

• MFT enhances the purchasing power of the investor.

• It is ideal for short-term investments for investors who want to profit from price fluctuations in the short term but don't have enough cash available.

• As margin, investors can use their existing portfolio of stocks and cash held by a broker.

• Investors can use margin trading to leverage positions in securities that aren't in the derivatives category.

• SEBI and the exchanges keep a keen eye on the securities eligible for the MTF, and margin requirements (in the form of cash or shares as collateral) are predefined by them intermittently.

• Securities that are margin traded are pre-defined by SEBI and the respective stock exchanges.

On the other hand, margin trading carries a far higher risk than standard stock trading in a cash account. This technique should only be considered by experienced investors with a high risk tolerance. Other investors should gauge the following risks before using an MTF:

• Margin Trading can seem lucrative and appealing to investors owing to the leverage, however, it also has the potential of losing more money than invested.

• It is required to maintain a minimum balance in the margin trade account. If you don't meet the minimum margin call, the broker has the right to square off the position by liquidating the assets.

Because of the benefit of leverage, margin trading is a potential technique for increasing profits on investment. However, it is important to remember that stock markets are very volatile, and leveraged holdings might increase the risk. Determine if trading on margin is a good idea for you based on your financial resources, investing goals, and risk tolerance.

To conclude, if you are getting your favourite stocks at discounts due to temporary market falls and want to cash in on that opportunity, the margin trading facility can work at best.