What is Leverage In Delivery Trading

Leverage in stock markets actually comes in various forms. There is the basic leverage of margin trading where you can pay a small margin and trade intraday. Leverage in the stock market also arises from the ability to pay just part of a delivery trade and borrow the rest in the market. Leverage in the share market can also arise from futures trading where you pay a futures upfront margin and take equivalent cash positions. One more form of leverage in share markets is when you use call and put options to replicate buy and sell trades in cash markets by just paying a small premium. Let us focus on leverage in delivery trading.

Leverage in delivery trading?

What is leverage in share market transactions? Simply put, leverage is the ability to trade a larger position with a smaller amount of trading capital. The small part of trading capital that you bring in as a trader is the margin, and the balance is the funded part, which is done by the banks or the NBFC attached to the broker. Intraday trading is also a form of leverage because you only pay a small margin and trade intraday. But that is only applicable for intraday trading. What if you want to take delivery for say 20-25 days. You can pay a small margin and borrow the rest of the money from the market. Here is how it works.

Say TCS is quoting at Rs.3200. You believe that after the latest results the stock can go up by 15-20% in the next 2-3 months. You want to make a good deal of money and for that you plan to buy 1000 shares of TCS. But that would entail an investment of Rs.32 lakhs and you don’t have that kind of liquidity available with you. The option is for you to borrow and invest in TCS. Here is how it would work.

Let us say that you can put in 25% of the funds as margin, i.e., Rs.8 lakhs. The balance Rs.24 lakhs you borrow as margin funding at a rate of 15% per annum. The actual rates can vary based on the stock you are buying and your relationship with the bank. Let us assume that you actually borrow Rs.24 lakhs on margin and after 2 months the price goes up to from Rs.3200 to Rs.3800. Suppose you decide to exit at this price, what would your profits be?

Your total realization would be Rs.38 lakhs (Rs.3800 x 100 shares)

You have paid Rs.32 lakhs for the shares, but in addition, you also paid interest on the borrowed money.

Interest cost is Rs.60,000 (24 lakhs x 15% x 2/12 months).

So, your total cost is Rs.32.60 lakhs and net profit is Rs.5.40 lakhs.

The most interesting aspect is when you look at the ROI or return on investment.

Your investment is only Rs.8 lakhs, so your ROI is a whopping 67.5% ROI in 2 months.

Had you put in your own money, ROI would be 18.75% (Rs.6 lakhs on Rs.32 lakhs)

Of course, 18.75% returns is still impressive but not as impressive as 67.5%. That is the power of leverage in the share market if used properly and judiciously. Actual returns will differ because we have ignored brokerage and statutory charges for simplicity purposes.

That looks too simple to be true and there are some risks to it. For example, the stock may go down and you may end up paying interest without earning anything on the stock. Also, if the price of the stock falls sharply then the financer will ask you to put more margins in cash. Remember, it is easy to say that margin trading multiplies profits. But it must be remembered that it also has the potential to multiply losses.

How to use leverage in delivery trading

Here we will only focus delivery trading by borrowing and investing for delivery. Here are 5 important rules to remember on how to use leverage in delivery trading.

1. Never stretch leverage too much. Put as much margin as you can afford. If you can pay 50% of the cost, don’t just pay 20% and borrow the rest. In leveraged trading, the basic rule is that lower the leverage the better it is.
2. Stay in stocks that are of high quality and predictable. Stocks with low management quality can be very volatile and your decision to leverage your delivery can backfire. Be cautious of the stocks you choose to trade with leverage.
3. Monitor the prices and the news flows continuously. There is no real alternative to that. If you find any news that is negative or has the potential to be seen as negative, it is best to step back and take a call on whether you should stay or exit.
4. Time is of essence. Remember, the longer you stay invested in the stock, the more interest you pay and the less of residual returns you are left with. Earning 15% in 2 months is a good leverage delivery idea, but earning 20% in a year is not a great idea.
5. Lastly, use stop losses and profit targets when you are doing leveraged trading. At some point, you must decide that it is not worth the risk to continue to hold the leveraged position. At that point just trigger the stop loss and exit your position. Also, when profit targets are met, don’t be too greedy because you are carrying a leverage position

How to start delivery trading

You start delivery trading by first opening a trading account using Online trading app. The next step is to identify the good stocks to buy and buy them in small quantities first and spread out your trades so that you get the best of price fluctuations. Delivery can be paying in the long run if you have the patience to hold on to good stocks for the long run.