Buying Options
What is purchasing power?
Purchasing power, also known as excess equity, is the money an investor has available to buy securities in a business environment. Purchasing power is equal to the total cash held in the brokerage account plus all available margin.
KEY POINTS TO REMEMBER
- Purchasing power is the money an investor has available to buy securities.
Purchasing power is equal to the total cash held in the brokerage account plus all available margin.
A standard margin account provides double the purchasing power equity.
A model day trading account provides four times the purchasing power equity.
Additional purchasing power amplifies both profits and losses.
How purchasing power works
While purchasing power can take on a different meaning depending on the context or the sector, in finance, purchasing power refers to the amount of money available to investors to buy securities on a leveraged account. as a margin account because traders take out a loan based on the amount of cash held in their brokerage account. Regulation T, established by the Federal Reserve Board (FRB), states that an investor’s initial margin requirement in this type of account must be at least 50%, which means the trader has double the purchasing power. 1,
Purchasing power of margin accounts
The amount of margin that a brokerage firm can offer a particular client depends on the risk parameters of the business and the client. Margin equity accounts typically provide investors with double the cash held in the account, although some forex brokerage margin accounts offer purchasing power of up to 50: 1,
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Plus a brokerage firm offers. leverage to an investor, the harder it will be to recover from a margin call. In other words, leverage offers the investor the opportunity to achieve higher returns with the use of greater purchasing power, but it also increases the risk of having to hedge the loan. For an account without a margin or a cash account, the purchasing power is equal to the amount of cash in the account.
In contrast, the brokerage firm charges interest on margin funds for as long as the loan is outstanding, which increases the cost of purchasing the securities for the investor. If the securities lose value, the investor will be underwater and will have to pay interest to the broker on top of that.
If the equity of a margin account falls below the level of the maintenance margin, the brokerage firm makes a margin call to the investor. Within a certain number of days, usually within three days, although it may be less in some situations, the investor must deposit more money or sell shares to make up all or part of the difference in the price of the l action and the maintenance margin.
A brokerage house has the right to ask a client to increase the amount of capital he holds in a margin account, to sell the investor’s securities if the broker considers his funds to be at risk, or to sue the investor if they do not respond to a margin call or if they have a negative balance on their account.
The investor has the potential to lose more money than the funds deposited in the account. For these reasons, a margin account is only suitable for a sophisticated investor with a thorough understanding of the additional investment risks and requirements of margin trading.
