Difference between a cash account and a margin account
If you are ready to enter the fascinating world of investing in the stock market then you will need to open a brokerage account. When you fill-in the application to open a brokerage account (which can be easily done online) you will need to indicate whether you want to open a cash account or a margin account. Let’s understand the difference between them.
If you are buying stocks through a cash account, then you are using the available cash in the account in order to take a long position in a stock. If you want to insert a buy order for shares of company ABC, you will have to deposit money in the account or sell shares of an existing position to fulfil the order. All transactions fully paid in cash. In addition to buying stocks, you can use a cash account also to purchase mutual funds and bonds. However, you cannot use a cash account to purchase stock options or futures. Nothing more to it. It is pretty straightforward.
On the other hand, a margin account enables traders to borrow money from the broker in order to purchase securities. The trader using a margin account is not obliged to borrow money for the purchase of stocks and can opt to pay 100% of the trade. If the margin account owner decides to use margin to purchase a portion of the security, the assets of the account are used as collateral by the broker. This type of account is used by investors taking short positions (trying to capitalize on the expectation that the share price of the stock will depreciate). Since the broker is lending the investor money to purchase the securities, he/she will have to pay margin interest on that amount. Being a margin account, it must also maintain a certain margin ratio at all times so if the investor happens to go below this value, known as maintenance margin, the broker will demand for a deposit or to close positions in order to bring the ratio back up. This is known as a margin call. If the trader does not meet the margin call, then the broker has the right to close any open positions to bring up value.
The amount that the trader must deposit in a margin account to purchase a security on margin or short sell is set by the Federal Reserve Board and is known as Regulation T. It is equal to 50% of the trade.