Margin Facility is a boon for traders and investors, especially those anticipating major price movement in the short term with insufficient funds. Margin Trading Facility also enables the utilization of securities available in your portfolio by keeping them as collateral.
On the contrary, margin trading also proves risky since the margin loans need to be repaid to the broker regardless of whether you earned a profit or incurred a loss. Using a margin facility can amplify profits. At the same time, margin trading can also lead to massive losses.
In this article, we will brief you on all pros and cons of Margin trading. Before proceeding further, let’s learn about the margin trading facility in detail.
What is Margin Trading Facility?
Margin trading allows you to purchase stocks at a specific volume/price you can’t afford. This facility enables you to pay a marginal amount of the actual value in cash or shares as security.
You can make significant money by holding more shares than you can purchase with your existing funds. However, if the stock’s value decline, you will lose more money.
Pros of Margin Facility
There are many advantages of stock trading on margin, some of which are listed below:
1. Increased Gains
You can buy more securities than you may have in cash. If the stock price (you invested in) goes up, you can achieve higher potential returns. It also increases your return on investment and maximizes your gains.
2. More Flexible
Buying on margin has more flexibility than other types of loans simply because margin accounts do not tie you up to a fixed repayment schedule.
3. Self-Fulfilling Opportunity
When your purchased securities increase in price, it will increase the collateral value and the leverage opportunities for MTF.
4. Diversification
If you do not have a surplus amount to invest, you can still build a diversified portfolio by buying on margin. Margin increases the purchasing power of traders. It implies traders can invest the money in purchasing different securities in their portfolios, such as stocks and bonds, and build a diversified portfolio.
Cons of Margin Facility
Some of the most common hazards that come with margin borrowing include:
1. Greater Loss
You buy more than what you may have in cash. It can negatively impact your portfolio when the price of the securities tumbles.
2. Interest Charges
You bear applicable account fees and interest if you buy on margin. The more you borrow, the more interest you need to pay. Every brokerage charges a different rate of interest on the borrowed sum. As of November 2022, the base interest rate on using MTF for stock trading is 12%.
3. Maintenance Requirements
Usually, there are 2 maintenance requirements if you want to buy on margin. The first one is to open a new position. The second is to maintain the existing position.
Opening a new position or maintaining an existing one by buying/holding shares on margin will require your portfolio to meet the broker’s maintenance margin requirement, which can be challenging if the asset’s price falls.
4. Liquidation
If the price of your asset falls abruptly, buying on margin can trigger margin calls. It may result in forced liquidations, leading you to sell the securities (often in loss). Or this situation could require additional equity investments or need you to deposit more funds.
Also Read: What is Margin Trading in Crypto?
Conclusion
Borrowing money from your broker to purchase stocks and increasing your purchasing power is the best way to boost your potential return. However, buying stocks on margin is also risky as you may lose more funds than you deposit in the margin account if the price of the underlying asset crashes. So always consider the pros and cons before executing MTF on stock trading.