What Is a Cash Account? Everything You Need to Know
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By Alexander ShishkanovAlexander Shishkanov has several years of experience in the crypto and fintech industry and is passionate about exploring blockchain technology. Alexander writes on topics such as cryptocurrency, fintech solutions, trading strategies, blockchain development and more. His mission is to educate individuals about how this new technology can be used to create secure, efficient and transparent financial systems.
By Tamta SuladzeTamta is a content writer based in Georgia with five years of experience covering global financial and crypto markets for news outlets, blockchain companies, and crypto businesses. With a background in higher education and a personal interest in crypto investing, she specializes in breaking down complex concepts into easy-to-understand information for new crypto investors. Tamta's writing is both professional and relatable, ensuring her readers gain valuable insight and knowledge.
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The investment world offers a variety of account types tailored to different goals, risk tolerances, and strategies. For many, the first choice is a brokerage cash account—a straightforward and transparent way to trade securities without borrowing funds.
But what is a cash account in trading, and how does it compare to alternatives like margin accounts? This guide will answer those questions and more, helping you decide if a cash account is right for your journey.
Key Takeaways
A brokerage cash account allows you to trade securities using only your deposited funds.
Unlike margin accounts, cash accounts do not involve borrowing or leverage, limiting potential losses to your available cash.
Day trading with a cash account is possible but requires careful cash flow management due to settlement period rules and the risks of good faith violations.
What Is a Cash Account?
A cash account definition will look like this: a brokerage account requiring investors to pay the full amount for any securities they purchase. Unlike a margin account, which allows traders to borrow funds from their broker to make trades, a cash account operates solely on the funds deposited by the investor.
How Cash Accounts Work
The mechanics of a cash account are simple and transparent. An investor must deposit funds into their account before making any trades. Once a trade is executed, the funds for the purchase are deducted from the account balance. Similarly, when selling securities, the proceeds are credited back to the account.
Account Settlement Rules
When you use a cash account to trade, you need to follow settlement rules. These rules are based on the T+1 settlement cycle, meaning a trade is officially completed one business day after you make it. Until this process is done, you can’t use that trade's money or securities.
Suppose you sell shares on a Monday. The proceeds from this sale won’t be available for use until Tuesday (one business day later). This waiting period can pose a challenge for active traders who rely on the funds from a sale to make additional trades. Before initiating a new transaction, ensure you have sufficient settled funds in your account to avoid violations.
Fast Fact
On May 28, 2024, the U.S. securities market transitioned to a T+1 settlement cycle, reducing the time for trade settlements from two business days (T+2) to one (T+1).
Example Scenario
Suppose you have $5,000 in your brokerage cash account.
You buy $3,000 worth of stock. The funds are immediately deducted from your account.
You sell the stock later for $3,200. However, you cannot use the $3,200 to make another trade until the transaction settles one business day later.
Margin Account vs Cash Account: Key Differences
Investors often compare margin accounts and cash accounts when choosing a brokerage account. Each has its unique characteristics, advantages, and risks.
What Is a Margin Account?
A margin account allows investors to borrow money from their broker to purchase securities, leveraging their capital. While this can increase potential returns, it also amplifies risks and introduces the possibility of margin calls, where the broker demands additional funds to cover losses.
Below is a comparison to help you understand which option might suit your needs better:
The Pattern Day Trader Rule and Cash Accounts
One of the key advantages of using a cash account is that it is not subject to the Pattern Day Trader (PDT) rule. The PDT rule applies to margin accounts and restricts traders from making more than three-day trades within a rolling five-business-day period if their account balance is under $25,000. Since cash accounts are exempt from this rule, traders with smaller account balances often prefer them to avoid these restrictions.
Who Should Use a Cash Account?
A brokerage cash account is best suited for certain types of investors.
Beginners: New investors who want a straightforward introduction to trading.
Conservative Investors: Those who prioritise safety over high returns.
Buy-and-Hold Traders: Long-term investors who aren’t focused on frequent trading.
Why Choose a Cash Account?
While both account types have their place in investing, a cash account offers distinct advantages for certain investors:
Ownership: Investors retain full ownership of purchased securities.
Simplicity: No need to worry about interest rates or borrowed funds.
Lower Financial Risk: With no leverage, the risk of significant losses is minimised.
Transparency: All trades are funded upfront, making costs and risks predictable.
Challenges of a Cash Account
Despite its simplicity, a cash account has some challenges:
Limited Buying Power: You can only buy with the cash you have, so you might miss bigger chances.
Slower Trade Turnaround: It takes one day (T+1) for funds from a sale to become available for new trades, which can slow you down if you trade often.
Less Suitable for Advanced Strategies: Practices like short selling, which require borrowed securities, are not available with a cash account.
Can You Day Trade With a Cash Account?
Yes, you can day trade with a cash account, but there are some important rules and limitations to keep in mind. Day trading means buying and selling a security on the same day, and with a cash account, you must follow settlement rules carefully to avoid issues.
- Use Only Settled Funds: You can only trade with money that has fully cleared from previous transactions.
- Avoid Good Faith Violations: A good faith violation happens when you buy and sell something without waiting for the funds from a previous sale to settle.
Tips for Day Trading With a Cash Account
Day trading in a cash account is all about careful planning and discipline. Follow these tips to make the most of your trading opportunities:
Plan Ahead
Think through your trades in advance and ensure you have enough settled cash to execute them. Avoid over-trading to stay within your account limits.
Split Your Funds
Divide your trading capital into portions to keep some funds available while waiting for other trades to settle. This staggered approach can help maintain activity without violations.
Monitor Settlement
Keep track of when your funds will settle. Understanding the T+1 rule and timing your trades accordingly can help you avoid violations.
Conclusion
A brokerage cash account is a straightforward, low-risk option for investors who prefer to trade with their own money and avoid the complexities of borrowing or leveraging their investments.
While it lacks the flexibility of a margin account, its simplicity and security make it an ideal choice for beginners, long-term investors, and anyone seeking a more conservative approach to trading.
