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Margin Account vs Cash Account: Which is right for you?

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In today’s article, we’re gonna talk about cash accounts, margin accounts, the pros and cons as well as which you should be using.

Do you use a cash account or a margin?

Just real quick, cash or margin. Would like to know what most of you are using.

What we’re gonna talk about today is kind of a brief overview of cash, margin, the pros and cons and kind of which one maybe you should be using, ’cause you can switch back and forth, which one maybe you should switch to as well.

Let’s start out with a cash account because it’s a pretty simple idea.

I think most of you will grasp it pretty quickly. When you have a cash account, you’re able to trade the amount of money in your account. So if you have a thousand dollars in your account, you can buy a thousand chairs of a $1 stock. That’s the most you can buy of that stock. That’s called your buying power.

So if you deposit a thousand dollars in your brokerage account, your buying power is $1,000. You can’t buy more than that total of a particular stock. That’s great because it helps kind of keep you out of trouble that you can get into with margin trading, which I’m gonna also talk about.

Now couple of the rules are, the nice thing with a cash account is you are not susceptible to the pattern day trader rule.

So many, many, many traders kind of misunderstand this. Don’t feel bad. There’s many misunderstandings that revolve around the pattern day trader rule. It’s very confusing and convoluted.

But if you have a cash account, you are not limited by those three trades in a rolling five day period like you are with a margin account. Now, one thing you do need to take into consideration, it doesn’t mean you can freely trade, day trading, because of the fact that most brokers will have different settlement periods, it’s called.

So when you’re trading that cash, they may not settle your cash for a day, two days or three days. So you have to be a little bit careful. You can’t freely day trade but the nice thing is you’re not limited by those rules of the pattern day trader rule.

Now let’s talk about margin trading and why you would wanna use it.

Most day traders, good or bad, use margin because of the fact that it allows several things.

Number one, it allows you to buy more stock than you have cash in your account. The other thing it allows you to do is short sell.

So with a cash account, you’re not limited by the pattern day trader rule but, keep this caveat down, you cannot short a stock with a cash account. And if you’re curious about shorting, we’ve got tons of article. Scroll through our feed, you’ll see ’em. We talk about shorting a lot. I won’t spend too much time on it here.

But with a margin account, you can short stocks and then you can also buy more than the cash in your account. Basically, they’re giving you leverage. You’ll hear that term a lot as well.

And what they’re doing is, in essence, loaning you money on a short period. So many brokers will have 2:1 leverage, 3:1, 4:1. Some brokers have even higher, which kind of gets out in the sketchy area.

If you’re using a broker that’s giving you more than 4:1 leverage, you might wanna be cautious using that broker. Pretty much any brokerage account will give you two to 4:1 leverage on your account.

So what’s that mean?

Remember back to my original scenario, you can buy a thousand chairs of a $1 stock if you’ve got a thousand in your account. If you’ve got 4:1 leverage, you can now buy 4,000 chairs of that $1 stock even though you still have that $1,000 in your account.

Now, I know what probably almost all of you are saying. You probably perked up at that point and you’re like, whoa, I can trade way bigger positions with a margin account. Let me in. Give me a margin account.

But remember, margin is a double-sided blade. It cuts both ways.

So the great thing about trading on margin is if you’re right, if you nail the trade, you’ve now got 4,000 chairs versus 1,000. So in an ideal scenario, that stock spikes a dollar. You now made $4,000 instead of $1,000 with the same amount in your account. Sounds awesome. I’m sure all of you would love that. I would love that.

But remember that blade cuts both ways. If you lose a dollar on that trade, you now lose $4,000, which would exceed your account.

Your broker would never let that happen but I think you see what I’m getting at here. Margin magnifies your winners but it magnifies your losers as well.

Highly recommend a margin account as a day trader, especially if you’re looking to short and you’re looking to trade these momentum stocks but you have to cut your loses quickly. You have to have a trade plan. That 4:1 leverage, that 6:1 leverage, that 10:1 leverage can wipe you out very quickly if you do not stick to that plan and do not keep your loses small.

If you’re looking to expand your trading knowledge, don’t forget to check out all of our other article.