Types of Brokerage Accounts
Now that you have decided to use the services of a broker, it is time to make your mind about the type of brokerage account you will open. You can choose from the following:
- Cash Account
This is the first account that you will open with your broker. Most online and discount brokers may have a requirement of depositing enough money to cover your trades may even before you open the account itself. This money will be put in a separate account (e.g. interest-bearing account) and when you are ready to execute trades the money will be transferred to your brokerage account. This is done with your first buy order.
The proceeds of a sold stock will be deposited back into your account so that they are ready for further purchases. You can also instruct them to make other transactions with this money.
When you have selected a particular purchase, you are given a time period within which you should pay the purchase. This time period is usually three days and is referred to as a settlement date.
The possibility of paying by a credit card also exists. But you should use this service unless you are sure that you will be able to pay back the balance as soon as the statement is received.
This type of accounts gives the right to brokers to execute stock transaction without asking for your authorization. A great degree of trust is required in order to open an account that gives brokers such a high level of freedom.
These accounts provide benefits for certain investors, but not to the common investor.
Margin accounts give their users the possibility of lending money for the purposes of purchasing stocks. The conditions of the borrowed money are more favorable.
Your broker may lend you up to 50% of the value of the purchase. Borrowing money from your broker for the purposes of purchasing stocks has its advantages in terms of increasing the profits you make.
Example: You have selected a stock that is worth $20,000, but you only have $10,000. So, you can borrow the rest of the money from your broker. Therefore, if the price of the particular stock doubles to $40,000, the investment you have in the margin account ($10,000) has increased four times.
Let's look at the other side of the coin, namely a fall in the price of the stock. In such a case, your broker will issue a margin call. This is done in case the price of the stock has fallen to such a level that it is lower than the amount your broker has lent you.
So, when you receive a margin call from your broker you can either:
- Sell the stock and cover the loan you have taken from your broker, or
- Raise the value of the account by depositing money in it, so that it is above the level of the borrowed sum.
However, the second option is not provided by all brokers, and you may end up with the first one.
Opening a OptionsHouse account to benefit from their low $3.95 stock trades (currently they offer 100 free trades) is a smart idea.
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