There are several types of brokerage accounts, but mostly, they are variants of two basic account types: margin account or cash account.

Put most straightforward, a cash account requires the client to pay in full for the securities they buy for their account. If they have $500, they can only buy $500 worth of securities, and can’t use the securities in their account as collateral to borrow more money.

A margin account allows clients to borrow money from their broker to buy securities, using those securities as collateral for the loan.

Benefits of a Cash Account

The primary benefit of a cash account applies to those who have small trading accounts, which do not meet the pattern day trader (PDT) required margin of $25,000. The PDT does not apply to cash accounts.

If a trader with a cash account has the capital to support this, they can make hundreds of trades on a given day. The kicker here is that cash used in a trade needs to settle before it can be transacted with again.

The next benefit is that cash account holders have no risk of receiving a margin call. A margin call is when your broker decides to terminate the margin loan they’ve extended to you. In the situation of a margin call, your broker will usually liquidate the securities you bought to cover the loan.

If you owe them any more money after that, you’re required to deposit more cash or securities to cover that loan.

Drawbacks of a Cash Account

The biggest drawback to cash accounts for traders is that after making a transaction in a cash account, the cash used must go through a settlement period, which is two days after the trade date.

For example, you use $1,000 of that to make a day trade on Monday. That $1,000 won’t be available for trading again until Thursday.

So, while the PDT rule doesn’t apply to cash accounts, to make several day trades in a week, you need to use small portions of your account. Imagine if you had a $1,000 trading account, to make 10-day trades in a week, you’d need to limit your position size to $100 for each trade.

The next drawback for cash accounts is especially hard-hitting to momentum traders who have small accounts: you can’t sell securities short. Short selling requires a margin account because you’re borrowing the securities from your broker.

This hurts many momentum traders who love to short sell parabolic penny stocks.

Read more here

Originally posted by:

www.warriortrading.com

February 7th, 2020