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Buying power refers to an investor’s total capacity to purchase securities. Buying power can be more than an investor’s available cash; it may also include the use of margin — i.e., leverage — that would increase their ability to buy assets.
Thus, buying power includes an investor’s available cash plus their available margin, as determined by their brokerage.
Generally speaking, a standard margin account allows the investor to borrow twice the amount of cash they have on hand. For example, if an investor has $10,000 in cash, their buying power is $20,000. But margin rules vary, depending on the type of security.
Note that not all investors qualify for a margin account, and therefore some investors’ buying power is limited to the cash they have available to purchase securities.
Key Points
• Buying power in investing refers to an investor’s total cash plus any margin, or leverage, available to purchase securities.
• An investor must meet certain criteria in order to open a margin account.
• The use of margin, i.e., borrowed funds, enhances an investor’s buying power and it also increases their exposure to risk.
• Different margin accounts may have different levels of buying power.
• Buying power is sometimes referred to as excess equity.
What Is Stock Buying Power?
Buying power, or excess equity, is a measure of how much capital an investor has available to trade stocks, options, and other securities.
There are different ways to measure buying power, depending on the type of account an investor has. Completing trades can reduce an investor’s ready capital, while selling securities and depositing the cash into their trading account can increase it.
There’s no standard buying power definition; it’s simply a way to gauge an investor’s ability to purchase securities, based on the total resources they have in their trading account, including cash and margin.
Buying Power vs Purchasing Power
Buying power is not the same thing as purchasing power, however. Purchasing power refers to the amount of goods or services a given unit of currency can purchase, when factoring in inflation.
Purchasing power comes up during discussions about how inflation may affect various industries. Purchasing power is an important factor in retirement planning, owing to the impact of inflation over time.
Buying Power vs Consumer Buying Power
Further, a consumer’s buying power, or purchasing power, is a measure of how much a consumer has on hand to buy goods or services. Thus, consumer purchasing power, as such, isn’t related to an investor’s buying power relating to financial securities.
How Does Buying Power Work?
To understand how buying power works, it helps to understand when this term comes into play. The types of accounts that use or reference buying power include:
• Cash brokerage accounts
• Margin accounts
• Pattern day trading accounts
What Are Cash Accounts?
Generally speaking, a standard brokerage account is a cash account. The investor can buy and sell securities with the funds they have in the account.
Retirement accounts, such as an IRA or 401(k) may have cash or cash equivalents as part of the portfolio, but these accounts are not considered cash accounts owing to how they are structured with regard to taxes and annual contribution limits.
Cash accounts and retirement accounts don’t use margin or leverage.
What Are Margin Accounts?
Margin trading involves using leverage, or borrowing cash, from a broker-dealer to purchase some securities (not all securities can be bought using margin). Investors must be approved by their broker to use margin.
In addition, margin accounts are closely regulated, and investors must understand the rules and restrictions pertaining to initial margin, maintenance margin, margin calls, and so on.
While trading on margin can double an investor’s buying power (or more, depending on the amount of allowable margin), it likewise increases the risk of loss if a trade moves in the wrong direction. In that case, an investor could lose money, plus they’d have to repay the margin loan with interest.
Pattern Day Trading Accounts
Pattern day trading can also increase buying power for margin investors who prefer active trading versus a buy-and-hold approach.
The Financial Industry Regulatory Authority (FINRA) defines a pattern day trader as any investor who executes four or more day trades within five business days, provided that the number of day trades represents more than 6% of the investor’s total trades in the margin account for that same five-day period.
Pattern day trading accounts have higher account minimums than standard margin accounts ($25,000 vs. $2,000). The initial margin is higher as well: Pattern day traders only need 25% cash equity to cover a trade versus 50% for standard accounts.
Recommended: Stock Market Basics
Buying Power Example
Assume that an investor has $10,000 in cash in a margin account. They want to use that $10,000 to buy stocks online. The brokerage has a 50% initial margin requirement, meaning the investor can take a position that’s twice what they have in cash. In that case, the investor’s buying power calculation looks like this:
$10,000 in cash multiplied by 50% initial margin requirement = $20,000 in total buying power.
How To Calculate Buying Power
The method of calculating buying power depends on the kind of account involved. With a standard brokerage account, this calculation is simple. An investor would simply add up the amount of cash they have available to trade. So if someone has $20,000 in cash in their brokerage account they’d have $20,000 in buying power.
With margin accounts, buying power is typically double the amount of equity they have in their accounts. So an investor who has $25,000 in a margin account would have $50,000 of stock buying power in that instance.
With pattern day trading, the buying power is four times the amount of equity. So, if an investor has $50,000 in cash or equity with which to trade, they could have up to $200,000 in buying power using pattern day trading rules. It’s important to note that if an investor exceeds their day trading margin limits, their brokerage may issue a margin call.
Margin Calls
A margin call can happen if the value of securities in a margin account drops below a set level, as determined by the brokerage. When that occurs, the investor may need to deposit cash or other securities in their account or sell securities to make up a shortfall. The more leverage a brokerage allows, the more difficult it can be for an investor to fill the gap when there’s a margin call.
What Happens If You Don’t Have Enough Buying Power?
If you lack buying power as an investor, you simply won’t be able to place trades on your chosen platform. If you try to execute a trade and lack the buying power, the trade will simply not execute. The specifics may depend on your chosen exchange or platform, of course, but generally speaking, a lack of buying power means that you lack the ability to buy.
How To Use Buying Power
If you’re interested in trading stocks, options, or other securities, having more buying power can work in your favor. Trading on margin can allow you to invest larger amounts of money and it has the potential to magnify your investment returns — but there’s also a much greater risk of loss.
Say you have only $5,000 to invest. If you qualify, you can open a margin account, which would provide an additional $5,000 in leverage (borrowed funds) for a total of $10,000. You then use this $10,000 to purchase 500 shares of stock which are trading at $20 each.
The stock’s price doubles to $40 per share. Now your shares are worth $20,000. You decide to sell, paying back the $5,000 margin loan to your broker. You also pay $50 in interest for the loan. And you pocket $14,050.
Now consider a different example: Say you used $5,000 cash to buy 250 shares of that same stock at $20 per share. When the stock’s price doubled to $40, you would sell them and pocket $10,000. You’re still coming out ahead, but trading on margin would have given you more buying power and thus bigger profits.
How Margin Amplified Losses
When using buying power to your advantage, you do have to consider the risks as well. Just as margin trading can increase your profits, it can also increase losses if the securities you purchase decline in value. With margin, it’s possible to lose more than the value of the initial trade, accounting for interest on the loan and any other costs.
Worse, there is a risk of a margin call if the cash and equities in the account fall below a certain level. In the event of a margin call, you’d have to liquidate some of your holdings or deposit extra cash to cover the difference — or the brokerage would do so on your behalf, to restore the proper maintenance level in the account.
The Takeaway
As noted, an investor’s buying power refers to how much they have at their disposal to purchase various investments and securities. Understanding how buying power works matters, especially if you’re a day trader or you’re trading on margin. And even if you’re a beginning investor, it’s still important to know what this means when it comes to your first brokerage account.
If you feel like you still need some guidance in calibrating your investment strategy, or furthering your understanding of buying power, it may be beneficial to speak with a financial professional.
Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
FAQ
What is buying power in simple terms?
Buying power, as it relates to investing, refers to how much an investor has to spend on investments, and can include cash in their account as well as using margin (leverage).
Why is buying power important?
Buying power gives an investor an idea of what they have to work with, and how they can leverage their assets and holdings to reach their financial goals. Understanding buying power may be particularly important for day traders or margin traders.
What is buying power vs cash?
Cash could refer to the investments you can afford to make with your wholly-owned assets, whereas buying power can also incorporate what you can borrow (margin) to purchase investments.
About the author
Rebecca Lake
Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.
Photo credit: iStock/solidcolours
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