Buying power refers to an investor’s ability or resources on hand to buy securities or investments. Investors who trade securities through an online brokerage account or margin account may see references to buying power or excess equity when reviewing the amount of money they have available to purchase securities.
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Put differently, buying power is a determination of an investor’s ability to make trades at any given time. Understanding the differences in what it means to have more or less power to buy stocks, options or crypto can help with shaping investment decisions.
Buying power, or excess equity, is a measure of how much capital an investor has available to trade stocks, options, and other securities. There are different ways to measure buying power, depending on the type of account an investor has. Completing trades can reduce an investor’s ready capital while selling securities and depositing the cash into their trading account can increase it.
There’s no standard buying power definition; instead, it’s simply a way to gauge an investor’s ability to trade, based on the financial resources they have in their trading account. It can also be thought of, or related to the purchasing power of the dollar.
Buying power, in this sense, is not the same thing as purchasing power, however. Purchasing power refers to the amount of goods or services a given unit of currency can purchase, when factoring in inflation. Often purchasing power comes up during discussions of how inflation may affect a portfolio’s returns.
Further, a consumer’s buying power or consumer purchasing power is a measure of how much a consumer has on hand to buy goods or services, not only investments or financial securities. Again, in this sense, the concept is broader and doesn’t relate strictly to investing.
To understand how buying power works, it helps to understand when this term comes into play. The types of accounts that use or reference buying power include:
• Margin trading accounts
• Cash brokerage accounts
• Individual Retirement Accounts (IRAs)
Margin trading involves using leverage, or borrowing cash, from a broker-dealer to purchase securities using the assets in a brokerage account as leverage or collateral.
Margin trading can increase an investor’s buying power above what they’d have in a cash account or IRA account. (Cash accounts and IRAs don’t use margin or leverage.) While trading on margin can enhance risk, it can also double the amount of capital an investor has available to make trades with.
Note, too, that there are distinctions that are important to understand when discussing leverage vs margin.
Pattern day trading can also increase buying power for margin investors who prefer active trading versus a buy-and-hold approach. The Financial Industry Regulatory Authority (FINRA) defines a pattern day trader as any investor who executes four or more day trades within five business days, provided that the number of day trades represents more than 6% of the investor’s total trades in the margin account for that same five-day period.
Assume that an investor has $10,000 in cash in a margin account. They want to use that $10,000 to purchase shares of stock. The stock has a 50% initial margin requirement. In that case, the investor’s buying power calculation looks like this:
$10,000 in cash divided by 50% initial margin requirement = $20,000 in margin buying power
Now, assume that same investor has $100,000 in cash instead to purchase stocks with. Using the same initial margin requirement, the calculation looks like this:
$100,000 in cash divided by 50% initial margin requirement = $200,000 in margin buying power
It’s important to remember that the value of the stocks the investor owns can determine the value of their margin account. When the value of the account increases, that can lead to more gains for the investor but it can also increase their odds of a margin call.
The method of calculating buying power depends on the kind of account involved. With a brokerage account or IRA, this calculation is simple. An investor would simply add up the amount of cash they have available to trade. So if someone has $20,000 in cash in their brokerage account they’d have $20,000 in buying power.
With margin accounts, buying power is typically double the amount of equity they have in their accounts. So an investor who has $25,000 in a margin account would have $50,000 of stock buying power in that instance.
With pattern day trading, the buying power is four times the amount of equity. So, if an investor has $50,000 in cash or equity with which to trade, they could have up to $200,000 in buying power using pattern day trading rules. It’s important to note that if an investor exceeds their day trading margin limits, their brokerage may issue a margin call.
A margin call can happen if the value of securities in a margin account drops below a set level, as determined by the brokerage. When that occurs, the investor may need to deposit cash or other securities in their account or sell securities to make up a shortfall. The more leverage a brokerage allows, the more difficult it can be for an investor to fill the gap when there’s a margin call.
If you lack buying power as an investor, you simply won’t be able to place trades on your chosen platform. If you try to execute a trade and lack the buying power, the trade will simply not execute. The specifics may depend on your chosen exchange or platform, of course, but generally speaking, a lack of buying power means that you lack the ability to buy.
Where you can find your buying power will depend on the specific platform or exchange you’re using, but typically, you’ll be able to find it somewhere in your account information or balances. For instance, if you’re investing with SoFi, you can find your buying power displayed in your account near its overall performance in the performance section of your Active Invest account.
If you’re interested in trading stocks, options, or other securities, having more buying power can work in your favor. Trading on margin can allow you to invest larger amounts of money and it has the potential to magnify your investment returns.
Say you have only $5,000 to invest. You open a margin account and your brokerage allows an additional $5,000 in buying power for a combined total of $10,000. You use this $10,000 to purchase 500 shares of stock which are trading at $20 each.
The stock’s price doubles to $40 per share. Now your shares are worth $20,000. You decide to sell, paying back the $5,000 margin loan to your broker. You also pay $500 in interest for the loan. That leaves you with $14,500 in profit.
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Now, say you used $5,000 to buy 250 shares of that same stock. Once the stock’s price doubles to $40, you sell them and rake in a $10,000 profit. You’re still coming out ahead but trading on margin would have given you more buying power and thus more profits.
When using buying power to your advantage, you do have to consider the risks as well. Just as margin trading can increase your profits, it can also increase losses if the securities you purchase decline in value. In the event of a margin call, you’d have to liquidate some of your holdings or deposit extra cash to cover the difference.
As noted, an investor’s buying power refers to how much they have at their disposal to purchase various investments and securities. Understanding how buying power works matters, especially if you’re a day trader or you’re trading on margin. And even if you’re a beginning investor, it’s still important to know what this means when it comes to your first brokerage account or IRA.
If you feel like you still need some guidance in calibrating your investment strategy, or furthering your understanding of buying power, it may be beneficial to speak with a financial professional.
Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
Opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.Buying power, as it relates to investing, refers to how much an investor has to spend on investments, and can include cash in their account, as well as margin.
Buying power gives an investor an idea of what they have to work with, and how they can leverage their assets and holdings to reach their financial goals. Understanding buying power may be particularly important for day traders or margin traders.
Cash could refer to the investments you can afford to make with your wholly-owned assets, whereas buying power can also incorporate what you can borrow (margin) to purchase investments.
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Purchasing power is the value of money in terms of the amount of goods and services it can buy. Because purchasing power can impact everything from consumer spending to stock prices and currency exchange rates, it can be an indicator of current economic conditions.
Purchasing power can also be described as "buying power." It measures how much you can buy with a unit of currency, such as a dollar.
The purchasing power of a dollar (or other currency) typically decreases over time as the prices on goods and services rise. For example, if you used to buy a tank of gas for $20 and you now pay $50 for the same tank of gas, your purchasing power has decreased.
Because purchasing power affects every part of the economy, governments track and measure it to keep tabs on their economy's health. They also institute policies to influence purchasing power and try to maintain a strong economy.
The consumer price index (CPI) is one way to measure inflation and purchasing power. In the United States, the Bureau of Labor Statistics keeps track of changes in the price of goods and publicizes those changes through the CPI.
The consumer price index regularly tracks the average prices of a market basket of goods purchased by consumer households. The basket includes common household purchases like transportation, housing, food and medical care. CPI is expressed as a percentage in comparison to the previous month. For example, the U.S. consumer price index increased 5% between March and March , according to the Bureau of Labor Statistics.
Purchasing power parity (PPP) measures purchasing power across different currencies in different countries. It assumes that purchasing power should be equal in various currencies at the same time. Basically, with PPP, one U.S. dollar would be able to buy the same amount of goods anywhere in the world, once converted to the local currency.
For example, if a bottle of soda costs $1 in the U.S. and 2 euros in France, the market exchange rate from the dollar to the euro would be 1:2. That assumes complete purchasing power parity between the two countries.
While PPP may be an ideal economic theory, it doesn't actually impact currency exchange rates. Instead, exchange rates are determined by supply and demand in the currency markets. Rather than a determinant of exchange rates, PPP is just a method of comparison for currencies, in terms of the goods and services they can purchase.
Economists use the PPP theory to compare a basket of goods in one currency to that of another, after accounting for exchange rates. The PPP is essentially the exchange rate at which one country's currency would have to be converted to the currency of another country in order to buy the same amount of goods and services. So if a foreign currency's value goes up against the dollar, that can affect an American's purchasing power in that country.
Purchasing power directly affects the amount of goods and services that money can buy. It also affects stock prices and general economic health. That's because if the buying power of a dollar decreases significantly, and it costs more to handle everyday expenses, more consumers will become cash-strapped. In turn, the health of the economy will drop.
One item that has a big impact on purchasing power is the current interest rate. When interest rates rise, purchasing power drops. For example, mortgage rates reached historic lows in . A person who purchased a new home in that year may have secured a mortgage with an interest rate of 3%.
Two years later, after aggressive rate hikes by the Federal Reserve, the same homebuyer may get a mortgage interest rate of 7%. That increased interest rate would significantly deplete the homebuyer's purchasing power. To achieve the same monthly payment the person got in , they'd have to buy a much less expensive home in to account for the higher interest rate.
Inflation, a broad rise in the cost of goods and services over time, erodes purchasing power. As prices increase, purchasing power decreases, and dollars won't stretch as far.
Consider the annual salary a middle-income household earned in . It may have paid for the mortgage on a home in the suburbs, weekly groceries and a vacation once a year. Four decades later, a family would have to earn almost three times as much to pay for the same home, groceries and annual vacation. That's an example of declining purchasing power over time, as the result of inflation.
Historically, significant changes in purchasing power have been a part of long-lasting economic shifts. For example, the Great Recession, a global period of general economic decline, occurred from to . Accompanied by increased unemployment and prolonged inflation, the Great Recession was marked by a deep decrease in purchasing power.
As a result of decreased purchasing power, research shows that consumer spending decreased substantially. One area in which people spent significantly less was dining out. Data from the U.S. Department of Agriculture's Economic Research Service shows that spending on food consumed away from home declined by 11.5% from to .
A shift in purchasing power doesn't just affect how much you can purchase in real goods, such as restaurant meals and groceries. Decreased purchasing power also can erode the purchasing power of your investments because when you cash out, the money you invested will be worth less.
Because of the risk of a drop in purchasing power, it's important to focus on investments that will earn a rate of return that is greater than the value of inflation. When deciding where to invest, consider factors such as your investment objective, time horizon, and risk tolerance. If you have a longer time horizon, your investments will have more time to recover, even if they suffer from a dip in purchasing power.
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