Buying shares with borrowed money can increase your purchasing power, but it also increases the amount you could lose. Margin Trading Facility (MTF) allows eligible investors to buy shares with only a percentage of the required amount being paid. The balance is paid by the broker. There are some key questions that investors should ask themselves before using MTF. Knowing how it works and if it would be suitable for your financial circumstances. By asking yourself some key questions you can understand the risk involved.
1. Do You Understand How MTF Works?
Investors can invest in stocks with the help of MTF by contributing a certain percentage of the total investment amount. The rest of the amount is invested by the broker as per the regulation, guidelines, and terms and conditions. But the investor must pay interest on the invested amount for a specific time.
Suppose an investor wants to invest in stocks worth 50,000 Rupees. He contributes only up to 20,000 rupees, and the rest is invested by the broker. Interest will be levied on the borrowed amount. The investor should still be accountable for this investment, even though the stock price drops.
2. Can You Afford the Interest and Other Charges?
There will be costs associated with borrowing to invest. The interest from your MTF will usually accrue, but charges such as brokers’ fees, statutory fees and any other applicable charges may apply.
Before you place an order, calculate how much you may have to pay to fund the position and compare it to what you could earn. As there is uncertainty involved when investing, be sure to look into whether the interest will still accrue if the stock moves sideways or lower.
3. What Happens If Share Prices Fall?
Market prices can move against an investor without warning. When shares purchased through MTF lose value, the investor’s equity in the position also decreases, while the borrowed amount remains payable.
For instance, shares purchased for ₹50,000 may fall to ₹40,000. The investor still owes the funded amount, along with applicable interest and charges. This can leave less capital to absorb further losses.
Brokers may require additional funds or securities if the position falls below prescribed margin requirements. If the investor cannot meet the requirement, the broker may sell some or all the pledged securities according to the applicable terms.
4. Do You Have a Clear Investment Plan?
MTF should not be used as a substitute for a well thought out investment strategy. Before using borrowed funds to invest consider:
- Do your research on how the company is performing financially, how it is doing in terms of business, and how it is valued.
- Consider how much money you can afford to lose in the market.
- Have clear criteria for when you will review or exit your position.
- Don’t borrow just because the stock price is increasing or gaining popularity online.
A Demat trading account can help investors by providing them with an electronic way to store their securities and trade any eligible securities in the market.
5. Can You Handle Unexpected Market Movements?
Stock can often fall quite dramatically after poor results, regulation changes, economic news or just unexpected news. If you have borrowed money to invest, it can become tricky to manage as you could lose money on the market and pay for the cost of the money.
You should not invest money that you need to cover essentials. If you are going to be under serious financial pressure due to the market fluctuating, then perhaps investing without borrowing would be a better option.
6. Have You Compared the Available Funding Terms?
MTF costs and conditions can differ between brokers. Comparing the terms before opening a position helps investors understand what they are agreeing to pay and maintain.
Check the following details:
- Interest Rate: Understand how interest is calculated and when it becomes payable.
- Eligible Shares: Confirm which securities qualify for funding.
- Margin Requirements: Check the amount you must contribute and the conditions for maintaining the position.
- Additional Charges: Review brokerage and other applicable fees.
- Liquidation Rules: Understand when the broker may sell securities to recover dues or address a margin of shortfall.
Conclusion
While MTF can give investors extra leverage, it can also cause them to have greater losses when compared to their own investment. Consider if it is affordable, what the margin requirements are and how you will react if prices fall. A Demat trading account may give you access to eligible funded transactions. However, it is important to know what is best for your individual situation and how much risk you are willing to take. If you are looking to use MTF on platforms such as 5paisa then be sure to check what fees are applied, what the funding requirements are and what the risks are.
