Margin funding is a common trading tool used by seasoned traders that allows them to invest with more than just their own finances and increase their profits through a short-term loan from their brokerage.
What is Margin Funding?
Brokerages across the globe offer traders the ability to invest in the market by using more than just their own funds, through a short-term loan against cash or securities. This facility is called margin funding.
Being able to purchase more stocks through borrowed funds increases the chances of cashing in profits on a favorable market. Traders make more profit investing through marginable stocks, for a relatively small amount of investment. Your purchase power depends not only on the price movement of your stocks but also on your daily trading volume.
Like every other loan, brokerages too charge an interest on margin traded securities. However, this interest rate isn’t as high as those on credit cards or personal financing loans.
How does it work?
A simple example: Nita has an investment corpus of INR 2 lakh and wishes to buy 1,000 shares Reliance that are currently priced at INR 200 per stock. On a favorable market, the value of her stocks shoot to INR 300, thus booking her a profit of INR 1 lakh i.e. 50% profit over her total investment.
Had Nita availed for margin funding from her brokerage of INR 1 lakh and invested only INR 1 lakh from her total corpus, using the short-term loan to buy the same stock, her returns from Reliance would have worked out to the same INR 1 lakh, minus the interest on the margin loan. For an investment, with half her total funds available in INR 1 lakh, she would have booked nearly 100% returns on her investment.
Benefits of Margin Funding
Leverage on liquidity: Credit can be availed instantly, without having to sell existing long-term securities. This means that you can acquire larger positions in the market through the shares already available in your portfolio.
Increased Trade Volume: You can easily increase the value of your portfolio using margin funding. Increased opportunities to trade will level up your existing portfolio.
Diversified Portfolio: You can spread your net further over the span of various share and security opportunities through margin funding. Diversification effectively mitigates market risk, if planned correctly.
Dividend & Other Corporate Benefits: Not only can you increase the volume of purchase, but also enjoy shareholder benefits such as dividends, bonuses, rights, etc. over the purchased shares.
Repayment Flexibility: You are allowed to pay the loan back as you see fit, as long as it does not exceed the maintenance margin limit. No prepayment charges are charged as this facility is adhered to as an overdraft. Interest is only applicable based on the loan’s usage.
The shares in your portfolio are revalued on a daily basis and drawing power is updated accordingly. Any appreciation in the value of the marginable securities you have purchased would automatically increase your drawing power.
While margin trading is practiced by seasoned day traders and professional investors, beginners can avail financial advice on using borrowed funds to invest in the market from expert financial advisors.