What is Buying Power?
Let me explain buying power to you directly: it's the money you, as an investor, have available to buy securities in a trading setup. We also call it excess equity, and it equals the total cash in your brokerage account plus all the margin you can access.
Key Takeaways
- Buying power is the money an investor has available to purchase securities.
- Buying power equals the total cash held in the brokerage account plus all available margin.
- A standard margin account provides two times equity in buying power.
- A pattern day trading account provides four times equity in buying power.
- Additional buying power magnifies both profits and losses.
How Buying Power Works
You should know that buying power can mean different things depending on the context or industry, but in finance, it specifically refers to the amount of money you have available to purchase securities in a leveraged account. This is what we call a margin account, where you take out a loan based on the cash in your brokerage account. Regulation T from the Federal Reserve Board requires that your initial margin in this type of account is at least 50%, which means you get two times buying power.
Buying Power of Margin Accounts
The margin a brokerage firm offers you depends on their risk parameters and your profile as a customer. Typically, equity margin accounts give you twice the cash you hold in the account, though some forex brokers might offer up to 50:1 buying power.
If a brokerage gives you more leverage, it becomes harder to recover from a margin call. Leverage lets you make bigger gains with more buying power, but it also raises the risk of having to cover the loan. For a non-margin or cash account, your buying power is simply the cash in the account. For instance, if you have $10,000 in a cash account, that's your buying power.
Buying Power of Day Trading Accounts
Pattern day trading accounts differ from regular margin accounts because they require a minimum equity of $25,000, compared to $2,000 for standard ones. In a standard margin account, you finance 50% of your stock positions, giving you two times equity in buying power. But in a pattern day trading account, you only fund 25% of the securities' cost, which provides four times equity buying power.
Take this example: if you have $50,000 in a day trading account, you could buy up to $200,000 worth of open trades in a day (that's $50,000 times 4 equals $200,000 buying power).
Example of Buying Power
Let's say you have $100,000 in a brokerage margin account and want to buy shares in Apple Inc. (AAPL). Your initial margin requirement is 50% to enter the trade—some brokers might require more than 50%.
To figure out your total buying power, divide the cash in your account by the initial margin percentage. So, divide $100,000 by 50%, and you can purchase up to $200,000 worth of Apple shares ($100,000 / 50% = $200,000). Keep in mind, the margin account's value changes with the securities you hold. The closer it gets to the margin limits, the higher your chance of getting a margin call.
Other articles for you
The Reserve Bank of India is the central bank responsible for monetary policy, financial regulation, and currency management in India.
The paradox of thrift explains how increased personal savings during a recession can harm the overall economy by reducing spending and demand.
A lock-up period restricts investors from selling shares for a set time to maintain stability in hedge funds and IPOs.
Groupthink is a psychological phenomenon where groups prioritize consensus over critical thinking, leading to poor decisions.
A Domestic Relations Order (DRO) is a court order that divides retirement benefits between spouses or dependents during divorce, potentially becoming a Qualified Domestic Relations Order (QDRO) for qualified plans.
Forward P/E uses projected earnings to evaluate a company's future value, varying by sector and offering insights despite potential inaccuracies.
A discretionary order allows brokers some flexibility in executing trades on behalf of clients without needing approval for every detail.
The economic cycle describes the fluctuating pattern of economic activity through stages of expansion, peak, contraction, and trough.
Basel I is the initial international banking regulation setting an 8% minimum capital ratio for banks based on risk-weighted assets to minimize credit risk.
Kondratieff Waves are long-term economic cycles in capitalist economies driven by technological innovations, lasting 40 to 60 years.