Cash trading accounts vs Margin trading accounts: What's the difference?
A brokerage account provides access to many asset classes (currencies, stock market shares, etc.), but in comparison to opening a bank account, the process of opening a brokerage account may seem daunting, especially for those who want to invest and trade for the very first time.
A question that almost always comes up with brokerage accounts is whether one should open a cash account or a margin account.
Main difference between a cash account and a margin account
In simple terms, the main difference between a cash account and a margin account is the leverage that most brokers offer to clients who want to borrow money to invest. To take advantage of this borrowing opportunity, you need to have a margin account.
Another difference is that a margin account based on contracts for difference (CFDs) provides you with the opportunity to sell "short"to bet on the decline of the price of a stock or a currency pair.
Margin accounts also provide you with access to a broader range of assets to trade (currencies, stocks, indices, ETFs, commodities, bonds).
This simple definition makes it easy enough to decide which type of account you want. In practice, however, there are other things that you should consider. Even if you don't intend to invest using leverage, there are situations where having a margin account can make things a lot easier.
How cash accounts work
Cash brokerage accounts got their name from the fact that all transactions in the brokerage account must be made with funds that are available at the time of the transaction. If you decide to buy a share, you must pay the full price of the share when you initiate the trade or transaction. If you don't have enough cash in your account, you won't be allowed to buy the shares in the first place.
The same problem arises when you sell stocks. In a cash account, you are not permitted to withdraw the cash proceeds from a sale of shares until the transaction is fully settled. You also have limited ability to use the proceeds of the sale to buy new shares because regulators carefully examine cash accounts to ensure that customers aren't attempting to circumvent the stricter restrictions that apply to them.
In the case of cash accounts, some strategies simply aren't within your reach. Futures trading requires the use of a margin, so you generally cannot trade futures with a cash account. If you like to trade options, cash accounts don't make option trading impossible, but there are only a limited number of options strategies that you can use with a cash account. For example, the purchase of call and put options is generally allowed, but if you want to sell options, then your positions must be covered either by shares of the relevant asset, or by enough money to face your obligations if the option is exercised. (See our article on the trading of vanilla options)
One of the advantages that many investors see in cash accounts is that brokers aren't allowed to take the shares they hold on behalf of their clients in cash accounts to use in their asset lending operations linked to short selling. Lending assets is an important source of income for brokers, but there is the risk that the parties to whom they are lending shares to may not be able to repay the loan.
Margin accounts: the basics
However, margin accounts involve entering into a credit agreement with your broker. You can use the margin that a margin account offers in a number of different ways.
First and foremost, margin accounts allow you to borrow against the value of your shares and other assets to make other asset purchases. This essentially gives you leverage on your investments as you can buy more stocks by borrowing than you can buy with your available cash. In exchange, the broker receives interest on the amount of the margin loan (SWAP). The limits of margin loans vary, but in Europe, for example, the maximum leverage of contracts for difference (CFDs) on stocks is 1:20 for professional traders and 1:5 for regular traders.
An example can make this situation easier to understand. Suppose you have €10,000 and you want to buy 1 share that's worth €100. With a cash account, you can buy up to 100 shares, but with a margin and leverage ratio of 1:5, your broker could allow you to borrow an extra $40,000, which would allow you to buy 500 shares worth €50,000 all while owing him just €10,000.
The dangers of margin accounts
Whenever you are dealing with your account's margin, there is always a chance that things can go wrong. The problem isn't inherent in the actual structure of the margin account, but in the way that you use your margin.
In the broadest possible terms, the main risk associated with the use of margin is that if the value of your position falls, you could end up with losses so large that your broker would be forced to liquidate your positions (Margin call or Stop Out). Margin agreements always give the broker the opportunity (in defined situations) to take steps to protect the account against greater losses than the assets in the account can cover.
Be smart when trading with a margin
Smart traders therefore have 2 choices. You can either stick to a cash account and never be tempted to have use a margin. This is the simplest decision for those who never want to worry about margins.
However, the best option for most traders is to open a margin account and not abuse the use of leverage. Margin accounts give you more flexibility in certain situations, but the key is to control the amount of leverage you use. As long as you don't put your entire account in danger, the use of margin can be a valuable tool.
Opening a brokerage account is scary for new traders, and understanding the difference between cash and margin accounts is one of the most difficult aspects of the process. When you understand the risks, you can more easily choose the account that suits your needs.
Investment horizon
CFD positions held for more than one day are subject to a fnancing fee (SWAP) on the margin used. CFDs are therefore more suitable for short-term trading such as scalping or intraday trading.
Cash accounts are more suitable for trading in the medium/long term, as brokerage fees will be lower than the cost of financing a CFD over a long period. For an investment horizon of over 1 month, opt for cash purchases.
Using the wrong broker can be very costly
In the long run, there is no better way to expand your wealth than by investing in the markets. But using a bad broker could have a big impact on the return on your investments.
Here is a broker that offers both types of accounts to invest in stocks and ETFs with or without leverage.
| Cash trading |  |  |
|---|---|---|
| Platforms | MetaTrader 5 | xStation MetaTrader 4 |
| Minimum deposit | 1€ | 1€ |
| Leverage effect |  | |
| Short selling | | |
| Margin call | | |
| Financing fees (SWAP) | | |
| Shares available | 4350 | 2235 |
| Share commissions (Europe) | 0.12%, min. 5€ | 0.12%, min. 10€ |
| Share commissions (United States) | $0.01 per share, min. $1 | 0.12%, min. 10$ |
| ETFs available | 158 | 174 |
| ETF commissions (Europe) | 0.12%, min. 5€ | 0.10%, min. 1.89€ |
| ETF commissions (United States) | $0.01 per ETF, min. $1 | 0.10%, min. 1.89€ |
 | |
| Margin trading (CFD) | | |
|---|---|---|
| Platforms | MetaTrader 4 and 5 | xStation MetaTrader 4 |
| Minimum deposit | 100€ | 1€ |
| Leverage effect | 1:5 | 1:5 |
| Short selling |  | |
| Margin call | 50% | 50% |
| Financing fees (SWAP) | | |
| Share CFDs | 3689 | 1718 |
| Share CFD commissions (Europe) | 1€ | 0.08%, min. 8€ |
| Share CFD commissions (United States) | $1 | 0.08%, min. 8$ |
| CFD ETFs | 300 | 103 |
| Commissions CFD ETFs (Europe) | 0.12%, min. 5€ | 0.08%, min. 8€ |
| Commissions CFD ETFs (Etats-Unis) | $0.01, min. $1 | 0,08%, min. 8$ |
| | |
| CFD trading involves a significant risk of loss, so it is not suitable for all trader. 74% to 89% of retail investor accounts lose money via the trading of CFDs. | ||