What is Margin Funding?
Margin financing, also known as the Margin Trading Facility (MTF), permits investors to purchase securities by borrowing money from brokers. In this, the investor does not pay the full value of the trade but pays a fraction of it, and the remaining value of the trade is financed by the broker.
What is Margin Funding in Trading?
Margin funding is a short-term loan facility extended by brokerage companies to those who participate in stock buying. It allows investors to counter any deficit in buying funds or doing transactions in certain sections of the market.
An investor who has demat and trading accounts can take advantage of the margin money provided by the stockbroker. Speaking generally, this generates the following requirements, as discussed below:
- To the broker's investment adviser
- Complete the application form on the broker's trading platform or website
How Margin Funding Works?
When the investor purchases securities with margin funds, the broker finances part of the transaction.
An investor potentially earns higher returns if the value of the securities appreciates and the profits trump the interest charged on borrowing money.
However, one significant drawback in this case is that, if the value of the securities falls, investors may be saddled with paying interest on borrowed funds and remain with a capital loss.
So, as the equity in the margin account is less than the maintenance margin, the broker may issue you a margin call.
When a margin call is made, the investor must:
- Deposit additional funds
- Sell some of their securities
This must usually be done within a specified period, often within three days.
Should the investor fail to put in fresh funds to meet the margin call, the broker shall be entitled to sell securities in the investor's account to settle the borrowed funds.
Margin Trading vs Normal Trading
FeatureMargin TradingNormal Trading
Capital requiredPartialFull amountBorrowingYesNoRiskHigherLowerInterest costYesNo
Benefits of Margin Trading
- Increased Purchasing Power: Investors get to buy further shares using a small amount of cash.
- Leverage Opportunities: It helps investors to capitalize on small market fluctuations.
- Short-Term Trading: The tool is useful for traders who are looking to utilize short-term market advantages.
Risks of Margin Trading
- Risk of Enhanced Losses: The losses can multiply if the market goes against the investor.
- Margin Risk: Brokers are bound to ask investors to pour in more money or sell securities if the margin falls.
- Interest Cost: Borrowed funds incur interest, which adds to the trading costs.
Who can get Margin Funding?
An investor is required to get into a margin trading account with the broker first, to become eligible for getting access to margin funding.
The eligibility criteria typically include:
- Having an active trading and Demat account
- Completion of margin trading agreements with the broker
- Depositing the required margin amount
- Maintaining the minimum margin balance required by the broker
If a broker fails to ensure adequate margins, your position's square can be taken off automatically.
Conclusion
Margin funding is a useful concept of allowing investors to achieve exposure to the market using borrowed funds. By allowing investors to trade with leverage, margin funding can enhance profit potential when markets move in the desired direction.
Yes, but it involves more risks because losses may pass the initial investment an investor makes if the market goes against his or her position. Therefore, margin trading is usually done only by those investors who understand what market risk really means and have experience managing leveraged positions.