Are you planning to trade on the stock market yourself and don’t know what type of account to open?
This article might help clarify things for you. We will explain the main differences between cash and margin accounts.
Cash or Margin?
If you are planning to open an account with a broker that offers multiple account types, as a retail investor, you will need to choose at least between two basic account types: Cash and Margin.
Neither account type is perfect; each comes with its own set of limitations, conditions, and opportunities.
Which account type to choose also depends on the investment or trading strategy you wish to pursue.
It’s also important to note that it depends on which broker you open your account with. In the USA, account conditions are set by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA). Requirements also vary depending on the type of assets and the investor’s risk tolerance. In Europe, account requirements are usually set by the European Securities and Markets Authority (ESMA).
CASH account
CASH accounts can usually be opened with any initial amount—there is typically no minimum deposit required. However, if you want to invest or trade, the absence of a minimum deposit is not a significant advantage. On a cash account, you can generally trade stocks, ETFs, and cryptocurrencies, while options trading is less common and depends on the specific broker’s offering.
As the account name suggests, you will trade exclusively with your own funds on a cash account.
The key feature of these accounts is that you can perform so-called day or intraday trades, meaning you can open and close a position within the same trading day.
Let’s use an example. You buy TSLA shares or options and, two hours later during the same trading session, you close the position with either a profit or a loss - it doesn’t matter. What’s important is that you can open and close positions within the same trading day.
The number of such trades you can make in one day is limited only by the amount of capital available in your account at market open.
Here’s another example. Before the market opens, you have $10,000 in your account. On that day, you can open and close positions worth a total of $10,000 in purchases. If you close a position opened in previous days that brings in an additional $1,000, this isn’t considered an intraday trade, but these funds cannot be used for further intraday trading. In such a case, your account would be marked with a Good Faith Violation (GFV). Five violations of this rule within 12 months will result in a 90-day restriction on opening new positions. The account will be set to “Close only” mode.
(The additional $1,000 gained from closing a position can be used to open a new position, but it cannot be traded intraday. In other words, you must keep such a position open until at least the next trading day.)
The GFV rule is applied by brokers in the USA and is not commonly used across Europe, but it’s advisable to check for a similar rule with your broker.
The choice of account depends on your preferred strategy, the broker’s conditions, and the amount deposited into the account.
A major limitation of cash accounts is that they do not allow trading futures and options spreads, even if the broker generally offers these instruments. Options spreads allow trading more complex structures and strategies while also reducing margin requirements, which is why options spreads are exclusive to margin accounts.
From the range of options strategies, you can use buying naked call and put options, and when writing options, you can only write naked put and call options. The possibilities and limitations of these strategies are probably beyond the scope of this article.
With a cash account, stock shorting is also prohibited.
MARGIN account
To open a Margin account, you will generally need at least $2,000. As the name suggests, the broker provides you with margin for trading, typically at a 2:1 ratio, meaning you will usually have double the deposited funds available for stock purchases. For the minimum account setup amount, this would be $4,000.
Unlike a Cash account, you are not allowed to make intraday trades on a margin account unless you have at least $25,000 in your account. Alternatively, you can make a maximum of three intraday trades within five trading days. If you violate this rule, your account will be marked with a Pattern Day Trader (PDT) flag. Again, this means you will only be able to close existing positions. This status can usually be reset by the broker, but only once within 90 days.
If you have more than $25,000 in your account, the intraday trading restrictions do not apply to you.
The fundamental difference between the two accounts lies in the range of trading instruments you can use. As mentioned earlier, a margin account allows you to trade futures, options on underlying assets including futures, and options spreads.
In addition to spreads that reduce margin requirements and define both the maximum profit and loss from an open position, a margin account offers much broader opportunities for advanced options strategies, whether combined with stocks or not. It allows the combination of different and uneven numbers of contracts to favor spreads to the long or short side, open synthetic positions, and write naked options on more expensive stocks, taking advantage of the offered margin in the short term.
As your deposit amount increases, so does the total amount available for trading because, as mentioned, the broker increases your available amount in the form of a loan. This amount is automatically available to you without any need to apply for it. If you use margin, the broker will charge you interest for its use.
On the other hand, margin carries risk that you must manage. Unlike a cash account, you can lose a much higher amount than what you initially deposited, precisely due to the margin. How to manage margin is beyond the scope of this article.
Key Differences Between Cash and Margin Accounts at a Glance:
CASH
Allows fast intraday trades
All trades must be executed and covered with your own capital; you cannot go into debt with the broker
Cannot trade options spreads or futures
Cannot short selling stocks
Can trade only naked options; in the case of selling a put option, any assignment to the underlying asset must be covered by available cash in the account
MARGIN
Ability to trade futures
Ability to trade options spreads
Intraday trading is restricted if the account balance is below $25,000 (applies to US brokers)
A multiple of your own capital is available for trading
Risk associated with margin trading must be managed
Which Account to Choose?
If you are reading this article, you probably do not yet have an open account and may not be entirely sure which strategy you will use.
If you plan to invest passively, buying individual stocks or ETFs, a cash account will suffice. If you wish to trade more actively, it’s definitely a good idea to start with demo accounts and test your trading strategies.
If you are planning on day trading, you need to check the broker’s conditions and any restrictions related to daily trading. For US brokers, with deposits below $25,000, you must choose a cash account for day trading; with a higher deposit, you can open a margin account, but you need to learn the specifics associated with the margin amount provided and manage risk accordingly.
Finally, for those interested in detailed requirements for margin on specific options strategies, including combinations with underlying stocks and formulas for calculating initial and maintenance margin at Interactive Brokers, you can find them here.
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