The U.S. stock market offers plenty of short-term and long-term wealth creation opportunities. If you’re planning on trading or investing in the U.S. financial markets, knowing the different types of brokerage accounts that are commonly offered is crucial.
Most U.S. stockbrokers offer two different types of brokerage accounts – a cash account and a margin account. In this article, we’re going to do a detailed comparison of a margin account vs. a cash account and ascertain the differences between the two.
What is a Cash Account?
A cash account is the simplest type of brokerage account that U.S. stockbrokers offer. With such an account, you can only trade with the funds you have deposited into it. This essentially means that you cannot borrow money from your broker or pledge your existing investments to purchase securities.
An Example of a Cash Account
Here’s a hypothetical example that can help you understand how a cash account works.
Let’s say you have ₹1,000 in your cash account. You wish to purchase the stock of Apple Inc., which is currently trading at ₹180 per share. With your balance, you can only buy 5 shares (₹1,000 ÷ ₹180) of the company. You cannot purchase more quantities of the company’s shares until you deposit additional funds into your account.
What is a Margin Account?
Let’s look at the concept of a margin account before checking out the differences between cash and margin accounts.
A margin account works differently from a cash account. With such an account, you can borrow funds from your stockbroker and use them to purchase securities. By using borrowed funds, you can amplify your purchasing capacity (leverage) significantly, potentially increasing the profits you get from your investments.
A margin account also allows you to short-sell stocks. In such a scenario, the broker will lend you stocks instead of funds, which you can sell on the market. Once you’ve achieved your profit target, you need to close out your short position by buying back the stocks and returning them to your broker.
In exchange for lending you funds for purchasing securities, brokers typically levy interest on the borrowed amount. The rate of interest is usually very high and is levied each day until you repay both the principal amount and the accrued interest.
If the broker lends stocks instead of funds, interest is levied on the total value of the lent stocks at a certain percentage each day until you repay the interest and return the borrowed stocks to the stockbroker.
An Example of a Margin Account
Now that you’re aware of what a margin account is, here’s a hypothetical example to help you understand how it works.
Assume you have ₹1,000 in your margin account. Your stockbroker is willing to offer 4X leverage for purchasing stocks. This essentially means that you can borrow up to four times the funds available in your margin account.
So, with ₹1,000 in your margin account, you can potentially borrow an additional ₹3,000 from your broker, effectively increasing your total purchasing power to ₹4,000. With this setup, you can now purchase 22 shares of Apple Inc. (₹4,000 ÷ ₹180) as opposed to just 5 shares with a cash account.
As you can see, the margin account has significantly increased your purchasing power, enabling you to potentially earn more profits than you would have had you traded using just a cash account.
Now, if the interest rate on borrowed funds is 10% per annum and you borrow ₹3,000 for 15 days, you would incur interest of ₹12.32 [(₹3,000 * 10%) * (15 ÷ 365)]. This interest will be deducted directly from your trading account along with the borrowed amount once you sell your stocks.
However, it’s crucial to remember that while borrowing on margin can increase your profits, it can also expose you to increased risk. If the market moves against you, you could end up with significant losses. In some extreme cases, the losses may even exceed your initial investment.
Key Differences Between a Margin Account and a Cash Account
Being aware of the differences between margin and cash accounts can help you easily determine which of the two is more suitable for your trading style. Here is a tabulated comparison of margin vs. cash accounts.
| Particulars | Margin Account | Cash Account |
| Leverage | Allows you to trade using borrowed funds (leverage) | Leverage is not available; you can only use your own funds to trade |
| Risk | Very high risk due to leveraging; the losses may even exceed your initial investment | Limited risk; the maximum amount of loss you can incur is limited to your initial investment amount |
| Minimum Margin Requirements | Stockbrokers have minimum margin requirements that you need to satisfy to open a leveraged position | No margin requirements |
| Interest Charges | Levied on the funds or stocks borrowed from the broker each day until you repay the borrowed funds along with the accrued interest | No interest charges are levied |
| Short-Selling | Allowed for both intraday and delivery trades | Allowed only for intraday trades |
Do Indian Stock Brokers Offer Margin and Cash Accounts?
Now that you’ve seen the differences between cash and margin accounts, let’s take a look at whether Indian stockbrokers offer these accounts.
The concept of separate accounts for cash and margin trading, as you’ve seen above, is unique to the U.S. financial markets. In India, stockbrokers typically offer a single account known as the trading account, which is linked to a demat account.
However, through this single trading account, you can place both cash trades as well as margin trades (via the Margin Trading Facility or MTF).
How Does the Margin Trading Facility (MTF) Differ from a Margin Account?
The Margin Trading Facility (MTF) is a specific service offered by Indian stock brokers. It allows traders and investors to buy securities by borrowing funds. While similar to a margin account, MTF operates under specific guidelines and regulations set by the Securities and Exchange Board of India (SEBI), which is the regulatory authority for financial markets in the country.
One key difference between MTF and a traditional margin account is that MTF is generally intended for short-term trading and carries stricter regulations regarding the use of borrowed funds. Additionally, Margin Trading Facility often requires investors to deposit and maintain higher margins and often have limitations on the holding period and the types of securities that can be traded.
Additionally, stockbrokers also create a pledge on the stocks traders and investors purchase via MTF. This is done as an additional safety measure; in the case of non-payment of the borrowed amount or the interest, brokers are well within their rights to sell the pledged stocks to recover their dues.
Conclusion
Understanding the differences between margin accounts and cash accounts is essential for any investor looking to trade in the U.S. stock market. Cash accounts offer simplicity and limited risk, whereas margin accounts provide the opportunity for increased buying power and potentially higher gains. However, it is important to note that trading through margin accounts can be very risky and could lead to significant losses if the market moves adversely.
That said, if you’re looking to trade on a margin in the Indian stock market, consider opting for the Margin Trading Facility (MTF) offered by a stockbroker. Unlike the U.S. stock market, you don’t have to open a separate margin account. All you need to do is place a request for activation of the facility on your trading account.
FAQs
What is the key difference between cash and margin accounts?
The key difference between margin and cash accounts lies in how the trades are funded. In cash accounts, you need to make the full payment for the trade from your own funds. In margin accounts, you can borrow funds from your broker to place an order.
Do cash accounts offer leverage for trading?
No, cash accounts do not offer any leverage for trading. You can only trade with the funds available in the bank account linked to the cash account.
Margin account vs. cash account: which one carries a higher risk?
Margin accounts generally carry a higher risk than cash accounts. This is because margin accounts involve borrowing funds to place a trading order in the market. This amplifies potential gains but also increases the risks associated with losses.
Do I need a separate margin account and cash account to trade in the Indian financial markets?
No, you do not need separate margin and cash accounts in India. You can simply open a regular cash or trading account and opt for the Margin Trading Facility (MTF) offered by your stock broker.
What is the Margin Trading Facility (MTF) in India?
The Margin Trading Facility (MTF) in India is a benefit offered by stock brokers that allows you to buy securities by paying only a portion of the total value upfront. The remaining value of the trade is funded through a loan from the broker.
