What is buying power?
Buying power, is the amount of cash in an individual’s brokerage account that is available for him or her to use for purchasing securities or opening new positions. A trader’s available buying power is going to be different based on several factors including whether a trader is using a cash account or a margin account.
Buying Power with a Cash Account
With a cash account, a trader’s buying power is going to equal the amount of settled cash they have in their account. When a trader makes a cash deposit into his or her brokerage account or sells a security, it generally takes 2 days for the cash or proceeds from that transaction to settle. Settlement periods can vary from broker to broker.
Other brokers have rules that allow you to use unsettled cash as buying power to open a new position, but do not allow you to close that position until the funds are settled without penalty. It is generally not recommended to open a position with unsettled buying power even if your broker allows it, because if you choose to or are forced to liquidate that position you will receive what is called a Good Faith Violation, or GFV. When a trader receives a good faith violation, his or her broker can penalize them with penalties including the freezing of trading with their brokerage account for a certain period. It’s a good idea to research the buying power policy of any broker you may be interested in opening a cash account with.
Buying power with a Margin Account
Some differences come into play when a trader opens a margin account. When trading with margin, a trader’s buying power will equal all the cash in a trader’s account plus any margin or leverage available to them. According to Investopedia: “A standard margin account provides two times equity in buying power. A pattern day trading account provides four times equity in buying power.” These are standard margin amounts for US brokers: you contact TradeZero’s 24/7 support to inquire how much margin you’re entitled to based on your location. On top of providing extra buying power, a margin account also eliminates the settlement period that comes with a cash account and a trader can freely trade all his or her capital. It is highly recommended that a trader holds off on using excess margin until they have reached a level of proven, consistent profitability with their trading strategy. Although the extra buying power that comes along with a margin account allows the possibility of amplified returns from winning trades, it also creates the possibility of amplifying any potential losing trades a trader might make. The lack of a settlement period also allows a higher frequency of trading.
To short sell stocks a day trader is required to use a margin account so it is advised they use it sensibly and with care.
Risk management tends to be an aspect that new traders develop and work on over time. Until a trader fully understands the risks involved with the extra buying power and the ability to trade more frequently that trading with a margin account provides, it is recommended they stick to using the buying power afforded to them within their cash accounts.
- Cash account buying power equals the total amount of cash in the account
- Cash accounts typically have a 2-day settlement period after depositing cash or selling securities
- Some brokers provide buying power with unsettled funds
- Opening a position with unsettled funds is risky; closing before settlement may result in a GFV
- Margin accounts allow for amplified buying power
- Margin trading buying power allows for amplified gains, but also amplified losses
- Margin accounts allow for higher frequency trading
- Margin accounts have minimum equity requirements
- You require a margin account to short sell stocks.
- ****Tradezero Homepage (July 24, 2022)
- ****Tradezero Quick Guide (July 24, 2022)
- ****Investopedia – Buying Power by Lucas Downey (August 23, 2021)
- ****Financial Industry Regulatory Authority – 4210. Margin Requirements (July 24, 2022)
This content (“Content”) is produced by James J. Ciccolelli. The Content represents only the views and opinions of Mr. Ciccolelli. Mr. Ciccolelli’s trading experiences and accomplishments are unique, and your trading results may vary substantially. TradeZero does not endorse the Content and makes no representations or warranties with respect to the accuracy of the Content or information available through any linked third party sites. The Content has been made available for informational and educational purposes only and should not be considered trading or investment advice or a recommendation as to any security. Trading securities can involve high risk and potential loss of funds. Mr. Ciccolelli is compensated by TradeZero for producing the Content and may also receive compensation for customers he introduces to TradeZero.
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