May 16, 2020

Cash Account vs Margin Account

Cash Account vs Margin Account
Cash Account vs Margin Account

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The biggest difference between having a cash account or a margin account with your broker for trading and investing is the ability to leverage your available capital. 

If you have a cash account, you will be transacting any trades or investments with the cash in that account by the settlement date. Cash accounts simply allow you to use the available capital in your account for trading and investing. This will decrease the amount of round trip trades you can make in a timeframe as you can run out of buying power of available cash that has settled and is ready to be used again.

As you buy and sell assets in your cash account you will not be able to make any more trades using the capital from that trade until after the transaction is settled within three days and your buying power is restored.  A cash account can deplete buying power through active trading and leave you waiting for trades to settle before you can execute your next buy order. That is the biggest downside for cash accounts for active traders. 

Cash accounts do not allow borrowing of additional capital from your broker for trading on margin. Investors commonly use cash accounts when they have no need for margin to day trade with additional buying power or sell stocks short. If you buy and hold investments for longer periods of time and do not want to own more assets than the value of your account then a cash account will be enough.

When using a cash account you will also have to wait for any trades to settle before you can make any withdrawal from the profits or the capital used in that trade. Any stocks you hold inside a cash account are not able to be lent out by your broker to sell short.

A margin account is more difficult to qualify for than a standard cash account as it involves the use of credit, loans, and leverage in trading and investing and requires a longer application and more information for the broker to approve. Margin accounts involve your broker granting you credit. 

A margin account is different in many ways from a cash account. A margin account allows a trader or an investor to both borrow against capital held and also borrow against the value of stocks and other asset positions in the account to buy new positions or even to sell short. 

You can use your margin and extra buying power in a few different ways. 

A margin account holder can use the access to a margin loan for leveraging their positions and profiting more from both long and short trades in the market by increasing trade size. If you have a margin account you can also withdraw money against the value of the account capital as a loan in the short-term if needed. 

Margin accounts also allow you to get a loan or borrow against the value of your current positions to buy different stocks and assets creating more diversification. This creates leverage because you can then buy more stocks through borrowing additional capital than is possible just from your available cash.

You must have a margin account for selling any stock short. Selling a stock short is selling something that you don’t own. Margin requirements are a type of collateral which safeguards the position and in most cases ensures that the shares of stock will be able to be bought back and returned when the short position is closed the buying power should be there. 

Margin accounts are best used for the ability to sell short and reset buying power more quickly and not having to wait for trades to settle. It can also be used to expand trade size with less risk through diversification of position correlations and trading systems. Making large leveraged trades on just one stock can be dangerous if the move turns against you and you do not stop your loss early. 

The broker collects interest on the amount of the capital used for the duration of any margin loan. The limits on the amount allowed for any margin loans can be very different by broker and by country of operation. U.S. based brokers normally allow borrowing of a maximum of 50% of the value of current positions for additional margin. Offshore brokers can provide more margin as they are not under the same rules as U.S. based institutions. Leveraged ETFs will be margined for less as they are more volatile assets with more risk. 

A margin account must keep a set margin ratio all the time or the trader will be issued a margin call that they must deposit more money to cover it or have their positions will be sold to raise the capital needed.