There are several types of brokerage accounts and brokerage firms that investors can use to invest in stocks. Full-service brokers provide investment advice and often charge high fees. Online brokers are popular because they offer secure interfaces that allow fast trading, trend and predictive analysis, and the ability to borrow funds or trade on margin.
Online stock accounts use specific terminology and display common figures that the trader should understand. The information provided by online brokerage accounts include the following figures that could be confusing to the novice trader: account value, cash value, and purchasing power.
The first figure, account value or total equity, is the total dollar value an investor has in their trading account including the cash in the account and the securities. This number is calculated by adding the total amount of cash in the account and the current market value of all securities and then subtracting the market value of any stocks that are shorted. It is essentially the worth of all positions if they were to be liquidated at the point in time the number is calculated.
The second figure, cash value, or cash balance value, is the total amount of cash the investor has available to use. This figure is the amount that that is available for immediate withdrawal or the total amount available to purchase securities in a cash account.
The final figure, purchasing power or buying power, is the total amount available to the investor to purchase securities. This amount includes both the available cash on hand along with any available margin.
A margin is the money borrowed from a brokerage firm used to buy stock or investments. It is the difference between the total value of securities held in the investor's account and the loan amount from the broker. If an investor buys on margin, they use the borrowed money to buy securities.
Stock brokerage margin accounts provide loans to investors so that they can buy securities. The loans are called margin loans, and they increase the stock purchasing power of the investor along with the potential to make greater profits, or losses, on those investments.
The purchasing power of an investor depends on the amount of equity in the account, which is the total value of the stocks and other investments held in the account minus any outstanding margin loan. Buying power, or purchasing power, also depends on the type of account the investor has. If the investor has a margin account, their purchasing power almost always will be greater than the cash value.
Limits on Purchasing Power
The Securities and Exchange Commission limits the value of stocks that an investor can purchase with a margin account. That limit is two times the equity in the margin account. Basically, the investor can borrow 50% of the cost of stocks. If the account is a pattern day trading account, for traders or investors that execute four or more day trades during five business days, the limit increases to four times the equity in the margin account but for day trading only.
The Risks of Buying on Margin
As the stocks in a margin account increase in value, so does the purchasing power. If the stocks go down, so will the investor's purchasing power. If an investor uses their full margin purchasing power to buy stocks, they will be at twice the leverage in a margin account. Thus, if your stocks go up by 10 percent, the investor gains 20% on their equity. A decline of 10% will mean a 20% loss. For day traders, the purchasing power gains and losses are multiplied by four.