As a new trader, one thing that took me some time to fully understand was the difference between Cash Accounts vs. Margin Accounts.
Some differences were easy to understand: In a cash account, I trade with what my own money; with a margin account, I can trade with my money plus some extra money loaned by the broker, i.e., leverage. As a general rule, I believe that I should only trade with as much money as I have. So if I lose, I only lose what’s mine.
So it may surprise you that I recently converted my account from Cash to Margin. In this post, I will explain some differences between the two, what caused me to switch, and the process I went through to switch.
When opening a Cash Account, there are no minimums on brokers like Webull, Moomoo, Robinhood or TD Ameritrade. You deposit your money, which can take up to 5 business days to settle and you trade with it.
Most brokers will give you access to $1,000 of your deposit right away if you make the deposit from your checking account during business hours. If you deposit less than that, essentially, you get access to all of it right away, even though the deposit still takes up to 5 business days to settle.
To open a Margin Account, you must deposit and maintain a balance of $2,000. Based on your account balance, trading profile and other internal risk assessment, they will offer you a level of leverage above and beyond your money.
When that leverage is used, you pay a fee (or interest) to the broker. If you’re using and returning it in a short period of time, it’s a very insignificant amount and you may not even realize it. But if you hold for longer periods, it can add up.
To short sell stocks, you MUST have a Margin Account. What you will also find is that the amount of leverage you receive varies from stock to stock (depending on how volatile it is), security to security (stocks vs. ETFs / ETNs), and also for day trade vs. overnight trade.
How Cash Accounts work
When you trade with a Cash Account, one of the most important things to keep in mind is Settled Funds vs. Unsettled Funds.
Let’s say you have $3,000 in settled funds in your brokerage cash account. That $3,000 is also called your buying power. If you buy $2,000 in stocks on Monday, you can sell them back on the same day (as a day trade) or any day after.
But once you sell them, you must wait for two business days before that amount (and any profit resulting from it) settles.
So let’s assume you sold them on Tuesday for a profit of $150, giving you total proceeds of $2,150.
On Tuesday, your total account balance, or buying power, is now $3,150. Of that, $2,150 is Unsettled, and $1,000 is Settled.
If you were to buy any stocks with your Unsettled funds on Tuesday or Wednesday, you would be required to hold on to those stocks until they settle on Thursday.
Two business days (also called T+2) from Tuesday, i.e., Thursday, all $3,150 is considered Settled.
However, if you were to buy stocks on Tuesday or Wednesday with the Settled funds ($1,000), you can sell them any time you please. But once you sell them, they will take two business days to settle. This process repeats with each transaction.
In a way, there is no limit to how many day trades you execute a day or a week with a Cash Account, as long as you are doing it with Settled Funds. So you can do a thousand $3 day trades with $3,000. But in reality, you would stand to gain very little with such small trades so you are likely to do a few big days trades.
Some people will not buy anything with Unsettled funds since you cannot sell those stocks if things start going sideways. It’s a risk.
If you buy and sell stocks with unsettled funds, each instance puts you on your broker’s naughty list and you receive a Good Faith Violation (GFV). If you receive 2 GFVs, you will only be allowed to trade with Settled Funds.
After 5 GFVs, you will not be able to buy any stocks for 90 days. You can only sell stocks that you already own.
How Margin Accounts work
Unlike Cash Account holders, Margin Account holders do not have to worry about Settled and Unsettled funds. Essentially, when you sell a stock and while it is being settled, your broker will let you leverage their money to buy and sell stocks.
Even though your broker may give you as much as 2-3 times your cash balance as leverage, you may want to consider using only as much leverage as the cash you have. That’s a good practice.
When buying certain securities like ETFs and ETNs, you may get only 1:1 leverage or even less because they are riskier.
Another thing to keep in mind is that your broker is always watching how much leverage you use to gauge the risk.
Each time you use some leverage, the broker will show you how much your Required Maintenance amount is. Your cash balance must equal that amount or higher.
If you decide to use all of your leverage (also called buying power), you could receive an Required Maintenance call (RM call). This basically means that they’ll ask you to deposit extra money in your brokerage account within a day or two to cover the risk.
If your investments are losing money, then you can definitely get an RM call. Don’t ignore that call or you won’t be able to trade.
Another difference between Cash and Margin Accounts is how Day Trading works. If you have less than $25,000 of your cash in your margin account, you are ONLY allowed to make 3 day trades in a rolling 5 business day period. If you use all 3 on a Monday, you cannot day trade again until next Monday. If you use 1 on Monday, 1 on Tuesday, and 1 on Wednesday, then you have no day trades on Thursday or Friday, 1 on the following Monday, 2 on the following Tuesday, and 3 on the following Wednesday.
If you execute a 4th day trade in a rolling 5 day period, you will be marked as a Pattern Day Trader (PDT), and you will receive an Equity Maintenance call (EM call). This means that you need to bring your account balance to $25,000 or your account will be restricted from any day trading. If you make another day trade before clearing up the EM, your account could be shut down and any positions could be involuntarily liquidated / sold.
$25,000: The Magic Number
If your margin account has a cash balance of $25,000 or higher, you can make unlimited day trades.
What can you do if you get a GFV or PDT?
The good news is that if it’s your first GFV or PDT and you contact your broker, they are usually willing to waive it. But if you are a repeat offender, don’t expect any mercy.
Who makes up all these rules? Webull? Robinhood? The Government?
These rules are set in place by FINRA, the government bodies that regulates stock trading, so all brokers must abide them.
It seems rather unfair for traders with small accounts to have restrictions on day trading, but it’s a rule that’s been around for a long time and supposedly to reduce risk.
When a Cash Account is Not a Cash Account
Webull and TD Ameritrade allow for both Cash Accounts AND Margin Accounts, but will not let you open a Margin Account with less than $2,000.
On the other hand, Robinhood and Moomoo only have Margin Accounts. They don’t always advertise it as such, so you may be under the impression that you have a Cash Account.
But neither Robinhood nor Moomoo will give you any leverage or margin if your account balance is less than $2,000. Also, for accounts greater than $2,000, margin is optional, so you do not have to have it.
As a consequence, you will find that Robinhood and Moomoo will only give you 3 day trades in a 5 business day rolling period if your account balance is less than $25,000.
Can I convert my account from Cash to Margin or vice versa?
Yes, brokers that support both account types allow you to switch from one to the other.
However, it is not as simple as it sounds. Before you can convert from Cash to Margin, you must have an account balance of $2,000 or higher, you must have own no stocks, have no outstanding trades, no buy orders and all cash must be settled. Once you initiate the process, it will take between 3 to 5 business for the conversion to complete. During this time, you are restricted from trading. This can lock you out and leave you watching and waiting.
Converting from Margin to Cash is similar. Essentially no moving pieces, and you need to wait 3 to 5 business days.
Why I changed my Account from Cash to Margin
I trade stocks every day, mostly swinging them overnight to sell for a profit. To maximize my returns, I tend to invest anywhere from 70-80% of my account, sometimes even higher.
As I mentioned earlier in this post, with a Cash Account, you have to constantly stay on top of Settled Funds vs. Unsettled Funds.
On a Discord trading chat group that I subscribe to, one of the moderators shared a very nice post on how to optimally use a Cash Account, the jist of it being that you should only use half of your account each day. This way, while one half settling after you sell shares, you still have access to half your account to day-trade or swing trade on any given day.
I’ve found it to be very limiting to only invest 50% of my account per day. Perhaps I’m wrong, but my goal is to make my money work for me each day.
Since my account balance was above $2,000, I decided that moving to a Margin Account would give me the freedom to trade without waiting on funds to settle. The hardest part was waiting the 3 business days for my account to convert. I won’t lie – it felt like an eternity.
Almost right away after getting a margin account, I made my first mistake: I bought stocks worth almost my entire cash balance. What could go wrong, right? Well, that same day, some of the stocks I owned started to go down. When the market opened the next day, the were going down even more. And then I was greeted by an RM Call. It freaked me out. I had two choices, either liquidate enough positions to bring my account within the Required Maintenance level, or deposit about a certain amount of money from my checking account by the end of the day.
I felt a pit in my stomach, but fortunately, I had just enough to spare to meet the RM Call. I didn’t want to liquidate my positions at a loss. Ultimately, that turned out to be the right decision since a few of them bounced back.
In the process, I learned a valuable lesson. Avoid investing more than 80% of your assets at any time, unless you’re confident it’s a winning day trade or overnight trade.