What is Buying Power?
Buying power is the total amount of cash and equity available in a trading account that a trader can allocate to buy additional securities.
It is sometimes also referred to as excess equity. Simply put, it is the money an investor has available to buy securities. It equals the total cash held in the account plus any available credit the account has on margin.
The term can take on a different meaning depending on the context or academic discipline. In finance, buying power refers to the total cash funds plus any credit available to purchase securities using leverage. A leveraged brokerage account is referred to as a margin account. Traders can take out a loan based on the amount of cash and securities held as collateral in their brokerage account.
- A cash account – is a type of brokerage account in which the investor must pay the full amount for securities purchased. An investor using a cash account is not allowed to borrow funds from his or her broker-dealer in order to pay for transactions in the account. For a cash account, the buying power is equal to the amount of cash in the account. For example, if a cash account has $10,000, that is the investor’s buying power.
- Margin account – typically allows you to borrow up to 50% of the purchase price for investments. Since the broker is loaning you money, it will charge you interest on the amount you borrow. It will also use the value of your stocks and other investments as collateral.
Regulation T, established by the Federal Reserve Board (FRB), mandates that an investor’s initial margin requirement in this account type must be at least 50%. However, this gives the trader two times the buying power.
Buying Power vs Purchasing Power
When investing, the terms buying power and purchasing power are often used interchangeably. However, in economic terms, there is a difference.
- Purchasing power is the value of a currency expressed in terms of the number of goods or services that one unit of money can buy. Purchasing power is important because, all else being equal, inflation decreases the number of goods or services you would be able to purchase.
- Buying power is the dollar amount of credit available to a customer to buy additional securities against the existing marginable securities in the brokerage account.
Margin Account Buying Power
The amount of margin a brokerage firm can offer a particular customer depends on the firm’s risk assessment and the customer. Typically, equity margin accounts offer investors twice as much as the cash held in the account. However, some forex broker margin accounts offer leverage of up to 50:1.
Margin Buying Power is the amount of money an investor has available to buy securities in a cash brokerage account or their margin account. For a margin account, it is the total cash held by the investor plus the unused margin still available. An investor’s margin buying power is usually twice as much as their own equity.
How to Calculate Margin Buying Power
Example with 50% margin
You have $10,000 worth of cash in your account and you wish to purchase ABC stock on margin. ABC stock has a 50% initial margin requirement, therefore your margin buying power is as follows:
$10,000 / 50% = $20,000 = Your Margin Buying Power
Example with 50% margin plus maintenance margin
You have $10,000 worth of ABC stock bought using $7,000 in cash and $3,000 on margin. Now you would like to buy XYZ stock (with a regular 50% initial margin requirement) on margin, how much is your margin buying power? Although the initial margin requirement of ABC stock is 50%, the maintenance margin requirement of ABC is 30%.
$10,000 x (100%-30%) = $7,000 → the maximum amount you are eligible to borrow. $7,000 – $3,000 = $4,000
Now you have used $3,000 of the available margin, your current available margin becomes $4,000, which is also your cash buying power.
$4,000 / 50% = $8000 is the margin buying power for purchasing XYZ stock.
Example with 75% margin plus maintenance margin
You have $10,000 worth of ABC stock bought using $7,000 in cash and $3,000 on margin. Now you would like to buy XXX stock (with a 75% margin requirement) on margin, how much is your margin buying power? Although the initial margin requirement of ABC stock is 50%, the maintenance margin requirement of ABC is 30%.
$10,000 * (100%-30%) = $7,000 is the maximum amount you are eligible to borrow. $7,000 – $3,000 = $4,000.
Now you have used $3,000 of the available margin, your current available margin becomes $4,000 which is also your cash buying power.
$4,000 / 75% = $5,333.33 = the margin buying power for purchasing XXX stock.
(Source: firstrade.com)
Buying Power of Day Trading Accounts
A pattern day trader (PDT) is a regulatory designation. It is for those traders that execute four or more day trades over the span of five business days using a margin account. Pattern day trading accounts work differently from regular margin accounts. Initially, they require a minimum equity requirement of $25,000, as opposed to $2,000. But, there is a very important difference regarding available margin:
- Margin account – a trader has to finance 50% of their stock positions in a standard margin account. This provides two times equity in buying power,
- Pattern day trading account – only has to fund 25% of the cost of securities purchased in a pattern day trading account. This gives the trader four times equity buying power. For example, if Daytradrr has $30,000 in a day trading account, they can purchase up to $120,000 worth of open trades within the trading day. This provides 30,000 x 4 = $120,000 worth of buying power.
Daytradrr Example
Let’s assume Daytradrr has $50,000 in a brokerage margin account and wants to purchase shares in Johnson & Jackson Inc. Daytradrr’s initial margin requirement is 25% to enter a trade. Some brokers may have an initial margin requirement greater than 25%.
To calculate Daytradrr’s total buying power, divide the amount of cash in the brokerage account by the initial margin percentage. Here, divide the cash balance of $50,000 by 25%. As a result, Daytradrr can purchase up to $200,000 worth of J&J’s shares ($50,000 / 25% = $200,000). But, the value of the margin account changes with the value of the securities held. The closer it gets to the margin limits, the greater chance of Daytradrr receiving a margin call.
Up Next: What Is Limited Power of Attorney (LPOA)?
A limited power of attorney (LPOA) legally appoints an agent to handle specific matters when the principal is unavailable or unable to do so.
For stock traders and brokers, it is an authorization that permits a portfolio manager to perform specific functions on behalf of the account owner. In general, the LPOA allows the manager to execute routine investment details and related business matters without contacting the account holder. Before signing an LPOA, the client should be aware of the specific functions they have delegated to the portfolio manager. Ultimately, the client remains liable for the decisions.
When creating a limited power of attorney, you are granting an agent the legal authority to act on your behalf. Under a general power of attorney, your agent has the authority to act on all matters. A limited power of attorney, on the other hand, limits the scope of your agent’s powers to a specific action or set of actions. Most brokers and portfolio managers execute investment-related details through a limited power of attorney.
