Jun 26, 2019
Written by:
Al Hill
In other industries, buying power describes the amount of purchasing power for goods and services.
What is margin purchasing power? In the context of this article, buying power is the available margin for trading.
Buying Power (Source – TradeKing)
In a margin account, buying power is the sum of the total cash and the maximum margin available.
For example, a margin account with $5,000 cash and a margin rate of 50%, has a total buying power of $10,000 (two times $5000).
The U.S. Securities Exchange Commission (SEC) prohibits investors from borrowing more than 25 percent of their cash in stock. [1]
For example, if you purchase $1,000 of IBM, you will need to have at a minimum 250 dollars in the account.
To this point, we have discussed margin requirements. But what happens once you are in the position?
Meaning if the stock goes against you, how much money do you need to maintain in your account before you receive a margin call?
In the below example, we will walk through the math for the maintenance requirement.
Example of initial margin and maintenance margin:
Once you fall below this maintenance requirement, you will receive a margin call from your broker. After receiving a margin call, you need to either deposit more cash or close out the entire position.
Full-Time Day Trader
According to the SEC, a pattern day trader is someone who has at least four day trades within five business days. [2]
Pattern day traders are allowed to use 4:1 intraday margin. So, an account with a value of $50,000 has a buying power of $200,000.
Under this rule, pattern day traders must maintain $25,000 in their cash account.
However, there is one caveat; this is only for intraday positions. For overnight positions, the margin requirement is double – 2:1.
Increasing the requirement makes sense because the brokerage firm would not want overnight exposure where a stock could gap up or down due to a news event.
The concept of buying power is a bit more complicated for options and comes down to the top of options trade you are placing.
Long options, for example, are short term in nature and due to the time decay do not have any loan value.
Check out this full table from TD Ameritrade which covers the various options requirements. Please note, it can get a bit complicated, so you will need to really understand what is required from you based on the amount of cash and trade type.
Forex which trades over the counter can have buying power as high as 50 to 1.
This buying power can vary from one brokerage to another.
The initial margin requirement can range from 3% to 10% on average. For a list of Forex maintenance requirements, check out this table from Forex.com.
Futures margin requirements are not as loose as Forex but runs a close second. You only need on average between 5% to 15% of cash on hand for your total position.
Check out this table from Daniels Trading which provides a list of requirements by futures type. What I really like about this table is the fact the broker calls out the initial margin requirement, maintenance requirements and then the daily requirement.
Using margin can be risky. [3] Most retail traders only think of margin as a tool to increase their profits.
They do not think of margin as a means to hedge against an open position.
Imagine if a trader goes all-in on a day trade with four times margin and the stock goes against them by 5%.
This would mean that trader just took a 20% hit on their total portfolio on one trade.
Hence, trading with margin is not for beginners.
While there are proper checks in place to ensure that you do not end up losing more than what you invested (including margin), it is not always that case.
The buying power in the markets are best used in moderation and a trader shouldn’t even think about utilizing all of the buying power simply because it is available.
Tradingsim currently has equities and futures in the platform. You can practice trading these security types to ensure you are able to stay within the set margin requirements.
Tags:
Day Trading Basics
Why Write An Article on Buying Power? Before we start clawing through the various types of margin accounts let me touch upon why I am writing this article. The amount of debt in the market from...
The concept of margin or margin trading is of utmost importance in the trading community, including futures and other derivatives markets spanning across different asset classes. Margin, in futures...
Day Trading Money Management
What is trading with Margin? Trading with margin is simply using borrowed money to buy or sell stocks short. Brokerage firms will allow you to use your cash on hand as equity in determining the...
