As a day trader, it's important for you to understand the terminology used in the industry. I'll start by covering the basic terms that you may already be familiar with, and then move on t more advanced concepts that you may have questions about.
As part of my Day Trading Courses, I'll provide you with a deeper understanding of these terms and how I use them in my trading career. If you have any questions, don't hesitate to reach out to me at otavio@conquesttrader.com
Cash Accounts
A cash account requires the client to pay in full for the securities they buy. If they have $50 they can only buy $500 worth of securities and can’t use the securities in their account as collateral to borrow more money. A margin account, on the other hand, allows clients to borrow money from their broker to buy securities, using those securities as collateral for the loan.
The primary benefit of a cash account is that it's not subject to the Pattern Day Trader PDT rule, which requires a minimum account balance of $25,000 for making more than three day trades within a five-day period. Cash account holders have no risk of receiving a margin cal which is when the broker terminates the margin loan and liquidates the securities.
However, the biggest drawback of a cash account is that cash used in a trade must go through a two-day settlement period after the trade date before it can be used again. This makes it difficult to make multiple day trades in a week with a small trading account. Cash account holders also can’t sell securities short, which is a technique used by some traders t profit from falling prices.
Margin Accounts
A margin account is a type of brokerage account that allows you to buy stocks by borrowing money from your broker. To open a margin account, you need to apply and be approved by the broker. The minimum amount to open a margin account is $2,000 and you will be given 2-to-1 leverage, which means if you have $2,000 in the account, you will have up to $4,000 in buying power.
However, the amount of margin required to buy different stocks and ETFs may vary, with most requiring a 50% requirement, meaning you have to put half of the cost of the trade before you are allowed to use margin. For example, if you want to buy 1,000 shares of a stock at $10 each $10,000 in total), you would have to put up $5,000 of your own money to complete the transaction. Some securities, like triple leveraged ETFs, may require up to a 90% requirement.
Margin accounts are also subject to the PDT rule and traders with less than $25,000 in thei account are limited to three day trades in a five-day period. Margin account holders are alsovulnerable to margin calls, which can lead to the liquidation of a position. Additionally, borrowing on margin through most retail brokers is expensive, as they charge several percentage points above the prime rate.
Conclusion
In conclusion, traders should consider their account balance, trading style, and risk toleranc when choosing between a cash account and a margin account. It's usually possible to change the account type by calling the broker, and most major US brokerage firms have 24 hour customer service to assist with the change.
Trading in a margin account can be very risky and should be taken seriously, as it can deplete your account quickly if not managed correctly. If you are considering opening a margin account, make sure you fully understand what you are getting into and be sure to practice risk management by always protecting your positions with stop orders.
