Imagine you get this hot tip about a share from a reliable source. You want to buy a large quantity but have only Rs 50,000 to invest. Your broker offers to lend you another Rs 50,000 if you promise to repay in a short while. It’s a tempting offer. If the tip proves correct, you stand to double your profits because you have twice as many shares. You could repay your broker and still be left with a lot of money. But there is a frightening flip side to this. If the share price takes a tumble, you would also lose twice of what you would have normally lost.
Welcome to the world of margin trading. This high-risk investment strategy has traditionally attracted only deep-pocketed investors and short-term punters. But now, an increasing number of small investors are giving in to temptation and picking up shares by paying only part of the total value.
Analysts say margin trading allows you to seize perceived opportunities in the stock market even when you do not have adequate resources. “It allows you to take a higher exposure in scrips that you expect to rise,” says Naresh Varshney, associate director of financial services company Centrum Direct. Varshney, 45, himself dabbles in margin trading and up to 60% of his investments in stocks are through this route. And he has made some good money from it, winning almost nine times out of 10.
Not everyone is as lucky though, not even seasoned stock investors such as Amit Azad. The 43-year-old chartered accountant has been buying and selling shares since he was in high school. “Today almost 80% of my savings are in stocks,” he says. But his experience with margin trading has not been that good.
“Margin trading essentially means over-leveraging yourself,” he says. According to him the common investor tends to book profits early and book losses when it is too late. “You might book profits in 10 trades but the loss in one trade may wipe out not only your profits but also a good part of your capital,” he says. That is the dark side of margin trading. Margin trading certainly increases your buying power but it also enlarges your risk. The leverage that it gives you is a double-edged sword, amplifying your gains and your losses to the same degree.
When you buy stocks, you can technically lose up to 100% of your money if the value of your shares falls to zero. But it’s much worse if you are doing margin trading. You can lose up to 200% of your money— your own plus what you borrowed. There are enough horror stories in this minefield to scare the novice. If your stocks crash, your broker will demand additional margin. If you can’t pay, he would sell the shares to recover his money. So even if the drop is temporary and the share is likely to bounce back, you end up booking a loss against your will.
Experts say you should invest through margin trading only if you have an above average understanding of the market. “Go for it only if you are very sure that the stock will go up,” says Kailash Mohan Rustagi, a Delhi-based financial consultant. Rustagi knows the market inside out but still burnt his fingers every time he tried margin trading.
Also, you should invest only that money in stocks which you can afford to lose. If putting a large chunk of your income in stocks is not prudent, emptying your provident fund account to invest through margin trading is financial hara-kiri. However, if you are a savvy investor and have the stomach for calculated risks, margin trading presents an opportunity to make double the profits with half the investment.
