Trading has become very diversified, with different tools and ways to invest your money and make an income. Newbies usually start trading with the money they have deposited into their accounts.
However, skilled investors use a balance between margin and cash trading accounts, where they can invest their money as well as funds they borrow from the broker.
Does this make margin accounts a better option to trade with? What are the dangers associated with borrowing money? Let’s answer these questions and explore more detail in the following.
Trading With a Cash Account
Cash accounts are simpler to deal with and more straightforward as they entail trading with the money deposited in the trader’s account. Beginners usually deposit money through online bank transfers or credit/debit card payments according to the minimum deposit requirements of the brokerage.
Traders can execute market orders using the money they have in their balance. For example, if a trader deposits $250, they can use the entire or parts of the amount to process one or more market orders.
This approach is easier to manage because traders can easily track their deposits, transfers and investments.
Trading with cash is preferable for new investors or risk-averse traders who do not want to take excessive risks or borrow money from the broker.
How Does a Cash Account Work?
Traders with cash accounts can only place orders using the amount in their balance. Therefore, they can only buy with the equity they have and can only sell using assets they own, such as stocks or cryptocurrencies.
All the profits and losses realised are against the cash amount used for the investment. For example, if the trader makes a 5% return on their $100 investment, they get the whole $105 for themselves without owing anything to the broker.
The only sort of payment would be if the broker charges transaction fees.
With cash trading accounts, transactions are settled in two working days, which is expressed as T+2. In other words, when a trader buys a company stock, it takes two days before they actually acquire the asset.
However, during the settlement period, they cannot access any funds they have used to buy the shares because they are locked and pending the settlement cycle. Additionally, if a trader wants to sell the stocks, they need to wait after the settlement period to own the assets and sell them to the market again.
Trading With a Margin Account
Margin accounts are more complicated than cash trading because they entail leverage trading and using broker’s funds. Investors use this approach to place orders on amplified positions, like 10 lots or $10,000 worth of shares, targeting more potential gains.
However, signified gains could also mean signified losses if the market moves sideways and the trader’s position ends up losing.
Therefore, margin accounts are mostly operated by skilled investors who take calculated risks in order to capitalise on unmissable market opportunities.
How Does a Margin Account Work?
With margin accounts, investors can leverage their trading positions, allowing them to place orders they would usually afford using their cash balance. Additionally, traders can short-sell stocks they do not necessarily own on the premise of borrowing the stocks from the broker and returning them at a lower value to make gains.
However, margin trading is riskier because it entails debt payback and margin requirements to open and maintain the leveraged position.
Margin Account Special Considerations
Despite the benefits of margin accounts, they must be treated with care because they involve several concepts, such as the margin call and margin requirements.
The margin requirement is the amount the trader must have and keep in their account as collateral in case the position defaults. This amount is the required minimum to open the margin account and is expressed as a percentage of the order or a fixed amount.
The margin call happens when the trader’s balance falls below the required margin, and the broker asks the trader to deposit more money in their balance to sustain the leveraged order. Otherwise, the position may go bankrupt, and the user’s account falls into a negative balance with a heavy debt to the brokerage company.
Conclusion: Margin or Cash Account?
Margin and cash accounts are two ways to invest in financial markets, allowing the trader to use the broker’s borrowed funds or relying only on the deposited cash in the investor’s balance.
Cash accounts are easier to manage and are preferable for new traders and those who do not want to deal with loan payments and excessive risks.
On the other hand, margin accounts are for risk-taking investors who can take some risks to capitalise on market opportunities that can potentially increase their gains massively, knowing that defaulting can bring additional dangers.
