What is Buying Power
Buying power, also referred to as excess equity, is the money an investor has available to buy securities when considering the term in a trading context. Buying power is the money an investor has available to buy securities and equals the total cash held in the brokerage account plus all available margin.
BREAKING DOWN Buying Power
While buying power can take on a different meaning depending on the context or industry, in the world of trading and investments, buying power refers to the amount of money available for investors to purchase securities in a leveraged account. This is referred to as a margin account, as traders are allowed to take out a loan based on the amount of cash held in the brokerage account.
Buying Power of Margin Accounts
The amount a brokerage can margin a particular customer depends on the brokerage house and the customer. Some margin accounts offer investors twice as much as the cash held in the account. Other margin accounts offer much more. The more leverage a brokerage house gives an investor, the harder it is to recover from a margin call. In other words, leverage gives the investor an opportunity to make increased gains with the use of more buying power, but it also increases the risk of having to cover the loan. For a non-margin account, the buying power is equal to the amount of cash in the account.
For example, assume an investor has $1 million worth of cash in a brokerage account. The investor wants to purchase common shares in company A. A retail investor's initial margin is normally set at around 50 percent to enter a trade, but maintenance margin, which is the amount of equity required for margin trading, can be as low as 25 percent but is normally 30 to 40 percent at retail brokerages. The total buying power is calculated by dividing the amount of cash in the brokerage account by the margin percentage. Thus, we divide the cash balance of $1 million by the initial maintenance margin requirement of 50 percent, or $2 million. As a result, the investor can purchase up to $2 million in securities. That said, the value of the margin account changes with the value of the securities held and the closer an investor gets to margin limits the more likely the chance of a margin call.