There is no doubt that margin and cash trading have become some of the most popular strategies traders use in the stock market. But despite their popularity, like every trading strategy, they too have their pros and cons.
This is why investors and traders must understand how these strategies work and where they stand compared to each other. Here’s a look at MTF vs cash trading.
Understanding MTF or Margin Trading Facility
Here is everything you need to know about the margin trading facility or MTF:
- A margin trading facility or MTF is a provision offered by brokers that lets investors borrow money from them to invest in securities.
- It gives investors access to securities whose value is more with the investor’s available capital.
- This provision can be opted for through a margin trading account, opened with the broker they are borrowing from.
- A minimum margin amount needs to be maintained in this account known as the maintenance margin
- When the margin trading account’s balance falls below the maintenance margin, the broker will make a margin call
- The margin call forces the investor to either add more cash to the account or sell assets to cover any shortfall.
- Brokers charge a nominal interest fee on the borrowed amount from the trader annually.
Understanding Cash Trading
Here is everything you need to know about cash trading and how it works:
- Cash trading is a conventional securities trading method.
- In cash trading, the buying and selling of securities takes place in cash.
- Cash trading involves an investor or trader’s capital.
- Cash trading does not involve any borrowing and thus no payment of interest either.
- The full amount of the trade is provided upfront in cash trading
- Cash trading offers investors more control ovеr any potential lossеs
- This provision also makes sure that the traders investing in the security have full ownеrship of it from thе get-go.
MTF vs Cash Trading
Listed below are the differences between MTF and cash trading:
| Aspects | Margin Trading Facility | Cash Trading |
| Nature of Leverage | MTF uses leverage and lets investors buy more securities over what they could using just the capital or cash they have | Cash trading does not use leverage. Here investors can only buy securities that they can afford with the capital they have available. |
| Level of Risk | Margin trading, when compared to cash trading is riskier as there is potential for greater losses especially when the market is volatile | Cash trading is less risky as investors use the capital that is available to them instead of borrowing from a broker thus risking margin calls. |
| Potential for Returns | The potential for returns is higher in margin trading as the position is larger. However, a larger position could also lead to exposure to higher-risk | The potential for returns in cash trading is dependent on the amount invested. The risk in this context is simply confined to the initial investment |
| Interest Costs | In margin trading, the broker loans the money to an investor and charges a small interest rate on this amount | As no money is borrowed, there is no interest involved. |
| Account Required | The margin trading facility needs a separate account known as the margin trading account that is to be opened with the broker the investor wishes to borrow from | Cash trading can easily be used with the help of a demat and trading account. |
In Conclusion
For investors who are looking to seek out the best investment strategy for themselves, understanding the differences between margin trading and cash trading is important.
With the help of borrowed funds, margin trading has the potential for higher revenues, but this is accompanied by potentially higher losses and issues like margin calls and interest rates. When it comes to cash trading there are less risks as investors don’t use borrowed capital.
Frequently Asked Questions
- What is Margin Trading Facility (MTF) and how does it differ from cash trading?
- Answer: MTF allows traders to buy securities by borrowing funds from the broker, whereas in cash trading, traders must fully fund the purchase with their own capital.
2. What are the main advantages of using MTF over cash trading?
- Answer: MTF offers the advantage of leverage, allowing traders to take larger positions than they could with cash trading, potentially leading to higher returns.
3. Are there any risks associated with Margin Trading Facility (MTF) that are not present in cash trading?
- Answer: Yes, MTF involves higher risk due to the use of leverage, which can amplify both gains and losses, while cash trading only risks the capital invested.
4. What types of securities can be traded under MTF and cash trading?
- Answer: Most equities can be traded under both MTF and cash trading, but some specific securities might be excluded from MTF by brokers due to volatility or liquidity concerns.
5. How does the settlement process differ between MTF and cash trading?
- Answer: In cash trading, the settlement is straightforward and typically occurs within two business days. In MTF, the borrowed funds must be repaid according to the broker’s terms, which could affect the settlement process.
