What is Buying Power?
When it comes to purchasing shares of stocks or different assets, and pretty much every thing else in the world, it takes some form of money or buying power. While in the real world, buying power can be things like cash or a credit card, when purchasing securities, buying power refers to excess equity or the money an investor has in order to buy those securities. Within your brokerage account, your buying power refers to any cash you have added, as well as any margin you might have been extended by the brokerage.
How Does Your Buying Power Work?
Depending on what industry you might be referring to, buying power can take on a few different meanings. As we mentioned, in terms of securities or stocks, buying power is how much you have available to purchase those stocks. When an individual has a margin account, it essentially allows traders to take out a loan based on the amount of cash held in their brokerage account. According to a mandate known as regulation T, an investor’s initial requirement for margin must be at least 50% – this means that the trader will have double the buying power extended to them from the brokerage.
How Margin Accounts Work?
When a brokerage extends an individual client margin, the amount of margin they offer, depends on the firm’s terms in regards to risk, and what the customer wants. In most cases, when it comes to the purchase of stocks, they will offer you twice the amount of cash within your account. Margin gives a client additional leverage, and this additional leverage allows you to make larger gains as you have more buying power. However, this can also increase your risk, as you will have to cover your loan amount. For a cash account without any margin extended, the individual’s buying power is simply the value of their cash.
Buying Power in Practice
It’s important to realize that the value of your margin account is dependent upon the amount of the value of the securities you are holding – the value will change depending on the value of your stock portfolio. In order to calculate your total buying power, you must divide the amount of cash within your brokerage account by what the brokerage has set as their initial margin percentage (generally, 50%). In the event that you might have $10,000 and your initial margin requirement is 50%, the math would dictate that you can no purchase $20,000 worth of stock. Its important to look into this if you choose to accept margin, as you might be subject to a margin call.
A margin call is when the value of an investor’s margin account falls below the broker’s required amount. If you have securities that are purchased with “borrowed money” or margin, and your account value dips below the minimum, the margin call is the brokerage requesting that you add additional funds to your account or sell some of your shares.
Day Trading & Margin
Within a Pattern Day Trading account, a day trader will have to have a balance of $25,000 or more within their account, in cash. In most cases, brokerages will then provide you with four times the buying power, as opposed to just two times. Therefore, with $25,000 in your account, you can purchase $100,000 worth of securities.
For more information on margin and buying power, be sure to delve deeper into the Stockia.io Education section.