However, despite being a good option of trading for the so-called 'bravehearts', you need to tread with caution. That is because while this mechanism increases your buying power, it enlarges your risk as well. In a way, it amplifies your gains and losses in equal proportions.
This explains why it is still not a recommended way of trading, although the lure of big money has always thrown investors into the lap of margin trading. So much so that an increasing number of small investors are now giving in to temptation of this high-risk trading strategy which had traditionally attracted only short-term punters and deep-pocketed investors.
Market regulator Sebi, from time to time, has been prescribing eligibility conditions and procedural details for allowing this facility.
"Sebi has, for instance, set certain criteria for the securities to be eligible for margin trading facility. It has categorized the securities under three groups, namely, Group 1, Group 2 and Group 3. The securities having mean impact cost of less than or equal to 1 and having traded on at least 80 per cent (+/-5%) of the days for the previous 18 months have been categorized as Group 1. A significant point to note is that the facility of margin trading is available only for Group 1 securities," says Mehul Kothari, senior technical analyst, Market Financial Intelligence.
Sebi has also set the eligibility criteria for brokers to provide the margin trading facility to their clients. For instance, currently corporate brokers with a net worth of at least Rs 3 crore are eligible for providing margin-trading facilities to their clients. However, before providing this facility to a client, the member and the client have been mandated to sign an agreement for this purpose in the format specified by Sebi.
It has also been specified that the client shall not avail the facility from more than one broker at any time. Also, at any point of time, the total indebtedness of a broker for the purpose of margin trading shall not exceed 5 times of his net worth. "Besides, the 'maximum allowable exposure' of the broker towards the margin trading facility shall be within the self-imposed prudential limits and shall not, in any case, exceed the borrowed funds and 50% of his net worth. The broker has to also ensure that the exposure to a single client does not exceed 10 per cent of his total exposure," informs Ashish Kapur, CEO, Invest Shoppe India Ltd.
To get a clear picture of how the margin trading mechanism works, consider the following example. Mr X bought 1,000 shares of ABC Ltd at Rs 210 in early 2012, using the margin finance facility. Assuming his broker offered him 50 per cent leverage on the transaction, this would mean that Mr X effectively paid only half the total transaction amount (only Rs 105,000 out of Rs 210,000) at the time of purchase. The balance, however, was borrowed from the broker/bank, which provided the margin finance facility.
This would have been a win-win situation for both the parties involved had the ABC Ltd share price risen to, say, Rs 220 in a week's time. Mr X would have been richer by Rs 10,000 (minus the interest that he would have to pay to the broker/bank for the borrowed money) and the bank/broker would have gained to the extent of the interest amount on the funds borrowed. Mr X's net profit as a percentage of his initial investment of Rs 105,000 would have been an attractive 9.5 per cent, within the short time-frame.
But, in reality, suppose the share price of ABC Ltd did not go that high. In fact, during the crash, it actually dropped to Rs 175. Mr X would then be incurring a loss of Rs 35 per share, exposing his financer to more risk if the share price were to plummet further.
"It is typically during such times that the broker is forced to make margin calls to clients, asking them to either deposit more money into their account or sell some of the securities in their account to meet the margin shortfall," says Kapur.
Now if Mr X failed to make good the margin shortfall, his broker would sell his shares for the stipulated amount in consideration. Thus, apart from losing his investment, Mr X would also stand to lose the opportunity to make any profit in the future, were the share prices to recover.
No comments:
Post a Comment