Trading Foundations: Accounts and Margin 🏦

The Story of Two Treasure Chests

Imagine you have a treasure chest. You can only spend what’s inside it. Simple, right?

But what if a magical friend said, “I’ll lend you extra gold coins if you promise to pay me back!” Sounds exciting—but also a bit risky!

This is the story of Cash Accounts vs Margin Accounts. Let’s dive in!

🪙 Cash vs Margin Accounts

Cash Account: Your Personal Piggy Bank

A cash account is like your piggy bank at home.

• You can only spend what you put in
• If you have $100, you can buy $100 worth of stocks
• No borrowing, no owing anyone

Example:

You have $500 in your cash account. You want to buy a stock priced at $50 per share. You can buy exactly 10 shares ($500 ÷ $50 = 10). That’s it!

✅ Why it’s great: No debt, no surprises, sleep well at night!

Margin Account: The Magical Lending Friend

A margin account is like having a friend (your broker) who lends you money to buy more stuff.

• Your broker says: “Put in some money, and I’ll double your buying power!”
• You can buy MORE stocks than you could afford alone
• But you OWE money back (with interest!)

Example:

You have $500. Your broker lends you another $500. Now you have $1,000 to invest! But remember—you must pay back that $500 plus interest.

⚠️ The catch: If your stocks drop, you still owe the full amount!

📊 Margin Requirements

Think of margin requirements as the “down payment” rule.

When you buy a house, the bank says: “Give me 20% upfront, I’ll lend you the rest.”

Brokers work the same way!

The 50% Rule (Initial Margin)

In the US, the law says you must pay at least 50% of the stock price yourself.

graph TD
    A[Want to Buy $1000 of Stock] --> B[You Pay: $500]
    A --> C[Broker Lends: $500]
    B --> D[Total Purchase: $1000]
    C --> D

Example:

Stock ABC costs $1,000. You must put in at least $500 of your own money. The broker covers the other $500.

The 25% Rule (Maintenance Margin)

After you buy, you must KEEP at least 25% of the stock’s value in your account.

Example:

Your stock is worth $1,000. You must maintain at least $250 equity. If your equity drops below this, trouble begins!

🚨 Margin Calls: The Scary Phone Call

A margin call is when your broker says: “Your account value dropped too low! Send more money NOW!”

How Does This Happen?

1. You buy stock with borrowed money
2. The stock price DROPS
3. Your equity falls below the maintenance margin
4. RING RING! Margin call!

graph TD
    A[Stock Price Falls] --> B[Your Equity Shrinks]
    B --> C{Below 25%?}
    C -->|Yes| D[MARGIN CALL!]
    C -->|No| E[You're Safe... For Now]
    D --> F[Add Money OR Sell Stock]

Example:

You bought $2,000 of stock (borrowed $1,000). The stock drops to $1,200.

Your equity = $1,200 - $1,000 (loan) = $200

Required = 25% × $1,200 = $300

You’re $100 short! Margin call!

What Happens Next?

• Option 1: Deposit more cash immediately
• Option 2: Sell some stock to pay down the loan
• Option 3: Your broker sells your stock FOR you (ouch!)

⚡ Leverage in Trading

Leverage is like a power multiplier in a video game.

• It makes your wins BIGGER
• It also makes your losses BIGGER!

The Double-Edged Sword

With 2:1 leverage (typical margin):

• $1,000 of your money controls $2,000 of stock
• If stock goes UP 10%: You gain $200 (20% return on YOUR money!)
• If stock goes DOWN 10%: You lose $200 (20% loss on YOUR money!)

Example:

Without leverage: $1,000 → stock rises 10% → You gain $100 (10%)

With 2:1 leverage: $1,000 → controls $2,000 → stock rises 10% → You gain $200 (20% on YOUR money!)

But the reverse is also true:

With 2:1 leverage: Stock drops 10% → You lose $200 (20% of your original money!)

🎯 Key Insight: Leverage AMPLIFIES everything—good AND bad!

💪 Buying Power

Buying power = How much stock you can actually purchase.

Cash Account Buying Power

Simple: Buying Power = Cash in Account

Have $500? Buy $500 worth of stocks.

Margin Account Buying Power

With margin: Buying Power = 2× Your Cash (with 50% margin)

Example:

Cash in margin account: $5,000

Buying power: $10,000 (your $5,000 + $5,000 borrowed)

graph TD
    A[Your Cash: $5,000] --> C[Buying Power: $10,000]
    B[Broker Loan: $5,000] --> C

Buying Power Changes!

After you buy, your buying power shrinks:

Example:

• Start: $5,000 cash → $10,000 buying power
• Buy $4,000 of stock → Used $2,000 of YOUR cash
• Remaining: $3,000 cash → $6,000 buying power

📅 Pattern Day Trader Rule (PDT)

The Pattern Day Trader Rule is like a speed limit for frequent traders.

What is a Day Trade?

A day trade = Buy and sell the SAME stock on the SAME day.

Example:

9:30 AM: Buy 100 shares of XYZ

2:00 PM: Sell 100 shares of XYZ

This is ONE day trade!

The Magic Number: 4

If you make 4 or more day trades in 5 business days, you’re a “Pattern Day Trader” (PDT).

The $25,000 Rule

Pattern Day Traders MUST keep at least $25,000 in their margin account at ALL times!

graph TD
    A[4+ Day Trades in 5 Days?] -->|Yes| B[You're a PDT]
    A -->|No| C[Regular Trader]
    B --> D{Account ≥ $25,000?}
    D -->|Yes| E[Trade Freely!]
    D -->|No| F[Account Restricted!]

What Happens if You Break the Rule?

• Account frozen for 90 days (no day trading!)
• Or deposit money to reach $25,000

Example:

Monday: Day trade 1 Tuesday: Day trade 2 Wednesday: Day trades 3 and 4

STOP! You’re now a Pattern Day Trader. If you have less than $25,000, your account gets restricted!

🎯 Quick Summary

🌟 The Golden Rules

1. Never borrow more than you can afford to lose
2. Margin amplifies EVERYTHING—respect it!
3. Know your maintenance margin—avoid margin calls
4. Count your day trades—don’t accidentally become a PDT!

You’ve now unlocked the secrets of trading accounts! Whether you stay safe with cash or venture into margin territory, you know the rules of the game. 🎮

Trade smart. Trade informed. Trade confident! 🚀