When you open a brokerage account, you must choose between a cash account and a margin account. This decision affects your buying power, trading flexibility, and risk exposure. Understanding the differences helps you choose the right account type for your trading style.
What is a Cash Account?
A cash account is the simplest type of brokerage account. You can only trade with the money you have deposited. Key characteristics:
- You can only buy securities with settled cash
- No borrowing from the broker
- No risk of owing money beyond your investment
- Must wait for trades to settle before reusing funds
Settlement Period: Stock trades settle in T+1 (one business day after the trade). Until settlement, the cash from a sale cannot be used for new purchases.
What is a Margin Account?
A margin account allows you to borrow money from your broker to buy securities. Key characteristics:
- Borrow up to 50% of a stock's purchase price (2:1 leverage)
- Trade immediately without waiting for settlement
- Pay interest on borrowed funds
- Subject to margin calls if account value drops
Key Differences Explained
1. Buying Power
Cash Account: Your buying power equals your settled cash balance. If you have $10,000, you can buy $10,000 worth of stock.
Margin Account: You can buy up to twice your cash. With $10,000, you have $20,000 in buying power. However, using full margin is risky.
2. Settlement and Trading Speed
Cash Account: After selling stock, you must wait for settlement (T+1) before those funds are available. This limits how quickly you can reinvest.
Margin Account: You can trade immediately because you are borrowing against your holdings. No waiting for settlement.
3. Day Trading Rules
Cash Account: No Pattern Day Trader (PDT) rule restrictions. You can day trade as much as settled cash allows. However, if you buy and sell before settlement, you risk a "good faith violation."
Margin Account: Subject to PDT rule if under $25,000. Limited to 3 day trades per 5 business days unless you maintain $25,000+ balance.
4. Interest Charges
Cash Account: No interest charges since you are not borrowing.
Margin Account: You pay interest on any borrowed funds. Rates typically range from 5% to 12% annually depending on the broker and your balance.
5. Risk Level
Cash Account: Maximum loss is limited to your investment. You cannot lose more than you put in.
Margin Account: You can lose more than your initial investment. If your positions decline significantly, you may owe your broker money.
Margin Call Risk
If your account value drops below the maintenance margin (usually 25-30%), you will receive a margin call. You must deposit more funds or sell positions immediately. Brokers can liquidate your holdings without warning in extreme cases.
Side-by-Side Comparison
| Feature | Cash Account | Margin Account |
|---|---|---|
| Buying Power | 1x cash | Up to 2x cash |
| Settlement Wait | Yes (T+1) | No |
| PDT Rule | Not applicable | Yes (under $25K) |
| Interest Charges | None | Yes, on borrowed funds |
| Short Selling | Not allowed | Allowed |
| Options Trading | Limited strategies | Full strategies available |
| Margin Calls | No | Yes |
| Maximum Loss | 100% of investment | Can exceed investment |
Cash Account Violations to Avoid
Good Faith Violation
Occurs when you buy a security and sell it before paying for the purchase with settled funds. If you sell stock and immediately use those unsettled funds to buy and sell another stock, you may receive a good faith violation.
Freeride Violation
Happens when you buy securities, sell them before paying in full, and use the proceeds to pay for the original purchase. This results in a 90-day restriction where you can only buy with settled cash.
Cash Liquidation Violation
Occurs when you pay for a purchase by selling other securities after the purchase date. Always ensure you have settled cash available before buying.
When to Choose a Cash Account
A cash account makes sense if:
- You are a new trader learning the basics
- You want to avoid the risks of leverage
- You prefer long-term investing over active trading
- You want to day trade without PDT restrictions (with proper cash management)
- You do not want to pay margin interest
- You want to limit your maximum loss to your investment
Why We Recommend Cash Accounts
We strongly recommend using a cash account for most traders:
- No interest charges: Margin accounts charge interest on borrowed money, which eats into your returns
- Limited risk: You can never lose more than what you invested
- No margin calls: You will never be forced to sell at the worst time
- Better discipline: Trading only with your own money encourages careful position sizing
- Simpler accounting: No need to track interest charges or margin levels
Interest Charges Add Up
Margin interest rates typically range from 5% to 12% annually. If you borrow $10,000 on margin at 8% interest, you pay $800 per year just in interest - regardless of whether your trades are profitable. This is money going straight to your broker.
Avoid Borrowing on Margin
We recommend not using margin to borrow money for trading. The interest charges and risks outweigh any potential benefits:
Interest Costs Reduce Returns
Every dollar you pay in margin interest is a dollar less in your pocket. Even if your trades are profitable, the interest charges reduce your actual gains.
Leverage Amplifies Losses
While leverage can increase gains, it also magnifies losses. A 20% drop in a leveraged position can wipe out 40% or more of your account.
Margin Calls Force Bad Decisions
When you receive a margin call, you must act immediately - often at the worst possible time when markets are falling. This removes your ability to wait for recovery.
The Alternative: Use a Cash Account
By using a cash account and only trading with money you actually have, you avoid interest charges, eliminate margin call risk, and maintain full control over your trading decisions.
Track Your Trading Performance
Pro Trader Dashboard helps you monitor your trades and performance regardless of account type. See your buying power utilization and track your results.
Can You Switch Account Types?
Yes, most brokers allow you to convert between account types:
- Cash to Margin: Apply for margin approval. The broker will evaluate your experience and financial situation.
- Margin to Cash: Usually can be done anytime. You must pay off any margin debt first.
Contact your broker for specific procedures and requirements.
Summary
Cash accounts offer simplicity, limited risk, and no interest charges. Margin accounts provide flexibility but come with interest charges, margin call risk, and the potential to lose more than your investment.
We recommend cash accounts for most traders. The interest charges on margin borrowing eat into your returns, and the leverage risk can quickly destroy an account. Trade with money you actually have, avoid borrowing, and you will have a much better chance of long-term success.
Ready to learn more? Read our guides on margin trading and choosing a broker.