In trading, the total amount of money that an investor can spend to buy securities for trading is called the buying power, also known as the “excess equity.” In a sense, this buying power is equal to all the money in your brokerage account and all the available margins that you can use to open a new position.
Tell me more about buying power.
Buying power may mean different depending on how it is used. For instance, buying power means the money an investor can use to purchase securities in a leveraged account. In a margin account, traders take a loan depending on the money they have in their brokerage accounts. According to the FRB/ Federal Reserve Board’s Regulation T, a trader with a margin account must have at least a 50% initial margin requirement. Hence, the trader has double buying power.
Margin accounts, cash accounts, and buying power
Brokers offer different margins depending on the client and the broker’s risk management. Most of the time, an equity margin account can provide at least twice the money in the investor’s account. Sometimes, they can give a maximum of 50:1. As we have said, it all depends on the broker’s or brokerage firm’s rules and regulations. Leverage is a double-edged sword. It can give you more buying power and profits, but it can also give you more losses. Hence, the bigger the leverage, the more significant risks.. So, if you get a margin call in a trade, it may be harder for you to recover if your account is too leveraged.
Now, if you do not want to borrow money to reduce your risks, you can opt for cash accounts. Cash accounts might mean lesser buying power, but it also means fewer risks. A cash account’s buying power is the total amount inside that account. Furthermore, if your cash account has $5,000, your buying power is also $5,000.
Day trading accounts and buying power
A margin account will require at least a minimum of $2,000. On the other hand, pattern day trading accounts have a minimum equity requirement of $25,000. A trader who has a standard margin account can finance half of their stock positions. So, they have double equity in buying power. Hence, they only need to shell out at least 25% of all the expenses to purchase securities in a pattern day trading account. It means that the trader has four times buying power in equity. For instance, you have a day trading account with a $25,000 amount. You can purchase open trades worth $100,000 in total for that trading day. Here, your buying power is $100,000 because $25,000 multiplied by four is $100,000.
Let us cite an example.
Let us say that you have a $50,000 margin account. Now, you want to buy shares from Company A. Your broker’s initial margin requirement is 50% to enter a trade. If we calculate your buying power, it would be something like this:
- Balance in the brokerage ÷ account Initial margin percentage = Buying power
- $50,000 ÷ 50% = $100,000
You can buy a maximum of $100,000 worth of shares from Company A. The margin account’s value depends on the securities. So, the closer the value is to the margin, the more the risks of getting a margin call.
Before we end our lesson, let’s recall that a standard margin account can give at least a double equity in buying power while a pattern day trading account can give four times. As the buying power magnifies, so do the profits and risks.
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