5 Reasons To Avoid Trading on Borrowed Money

Apurva Sheth
Do you trade on borrowed money? Have you ever borrowed money from your family, friends, or relatives to trade? Have you taken a loan from your broker to trade in the market?

If the answer to any of these question is yes, then you are running the risk of financial ruin. Today, I want to talk about the risks of trading with borrowed money and why one should avoid it.

But before we look in to that, let's look at the various sources one could borrow money from for trading.

First is obviously your near and dear ones, your relatives or friends. They may lend you money on easy terms. They might not even charge you interest or take collateral.

Second is the money borrowed by a broker or financial institution against securities. This is known as margin funding. The broker takes your shares and securities as collateral and loans money against it. They loan a certain percentage of the value of these securities and charge interest anywhere between 15 and 21%.

And finally, while some brokers only allow to buy shares if your account is fully capitalized, others might allow to make payment within two days of buying the shares (T+2). Some even offer up to five days (T+5).

A lot of retail traders use this window between buying shares and making payment as an opportunity to trade without money. In this case, the broker is lending money for a very short time (not more than five days) at zero interest. Many retail traders buy shares with the intention to hold them not more than five days.

These are the three most common ways to borrow money to trade. Now let's see why one should avoid borrowing money to trade at any cost.

  1. One should only trade with money one can afford to lose

  2. One of the cardinal rules of trading is that one should only trade with money one can afford to lose. And borrowed money is money one cannot afford to lose. You have to return it one day or another. Trading is a risky activity and one can never be sure of the returns.

    The strategy you're following may have been successful in the past, but you can never know if it will stay successful in the future. If the trading returns are not what you expected, then one may not be able to repay the loan on time. And failure to do so can spoil your relationship with your family and friends or attract heavy penalties if you borrowed from commercial entities.

  3. Intense pressure

  4. The interest clock is constantly ticking if one has borrowed money from a broker or financial institution. This is an additional cost that one has to incur. And there's always the risk that one won't find high-probability trades. In which case, one may still go ahead with sub-optimal trades because one doesn't want his borrowed money to sit idle.

    There is nothing wrong with sitting on cash when trading when the environment isn't conducive to your style of trading. But this is difficult when trading on borrowed money, as the pressure to earn is always there.

  5. Emotional Stress

  6. When one trades on borrowed money, he adds more stress to the already stressful activity of trading. Stress in trading comes from uncertainty and drawdowns. Many find it difficult to handle just one of these even when they are trading with their own money. But when you add third element - borrowed money - to the equation, the emotional stress rises multifold. There is more than money at stake when one trades on borrowed money - relationships, pride.

    Traders have to make decisions based on the greed and fear of others. But when one trades on borrowed money, he eventually ends up trading his own fear and greed.

  7. Market crashes

  8. Booms and busts are part of the market cycle. Like rallies, market crashes are inevitable. And nobody knows when either will happen.

    If one is trading on borrowed money and the market sees a sudden collapse, one may suffer huge losses and find it impossible to meet interest payments. Further, the shares one has kept as collateral will also drop and the broker may ask you to recapitalise your account. If one fails to do so within the stipulated time, the broker may selloff these shares, further aggravating the losses. This was common during the financial crash in 2008.

  9. Hurts Productivity

  10. With so much at stake, it's hard to resist the temptation to constantly check the markets. I've seen many people hooked on to their smartphones throughout the day checking the latest news and updates on the stocks they're trading. This diverts attention from the task at hand and diminishes productivity.

    Trading on borrowed money does more harm than good, and it should be avoided completely. At Swing Trader, I recommend all our subscribers to trade only with money they can afford to lose. And this money should be a very small portion of their overall portfolio.

    This allocation will of course vary from person to person depending on one's personal financial situation and risk tolerance. To find what works best for you, we recommend you talk to your investment advisor or financial planner as these guidelines are merely indicative.

Do you trade on borrowed money? Share your views in the Club or share your comments here.

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5 Responses to "5 Reasons To Avoid Trading on Borrowed Money"
n.h.pandurangi
16 Jul, 2016
A very nice piece of advice indeed. Hope to read more such articles. Like 
babu
10 Jul, 2016
In the late 1990s just before dotcom bust ,the professionals who were getting paid handsomely in the software domain could not keep away from stockmarkets.The fact that markets keep going up whetted their appetite.Stories of huge money being made added fuel to their greed.They borrowed money and tarded ,not in sensex stocks,but in many fancy names,many of which have long since disappeared from the bourses. It is quite predictable what happened when the dotcom bubble burst. The IT profesionals also dabbled in not so well knon real estate. Many of them learnt the lesson the hard way.Many never went back to the market.Few were ruined financially.Like 
shyamal saha
07 Jul, 2016
It is absolutely correct and it is expected that everyone should follow the guideline in future.But in my case I used to purchase share from my own pocket money say about Rs.50000/- to Rs.100000/- at a time when market is going at lower stage price of the share coming down abnormally . I take the advantage of brokers T5 facility when any share value are not moving upward stage for period of 15 to 1 month of my satisfaction or it may go downward stage then I change my portfolio i.e. sale the existing co`s share to other company then I take facility of T5 .Like (1)
Manu Agarwal
07 Jul, 2016
I want to know the past performance of swing trader for last 6 six months if possible so that I can subscribe for the service.Like 
Roy
07 Jul, 2016
AA good thought provoking article with advice every investor should know .Like 
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