Buying power — which is different from purchasing power when it comes to investing — is the amount of money an investor has on hand to buy securities, cryptocurrency, options or any other kind of financial instrument.
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Why Does It Matter?
It’s important to understand the concept of buying power, as it helps determine how much money you have to trade with.
As Sofi explained, there are different methods to measure it, generally depending on the types of accounts investors have.
For instance, Sofi noted that trades can decrease an investor’s capital, and on the other hand, selling securities and depositing the cash into their trading account can increase it.
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“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 … related to the purchasing power of the dollar,” according to Sofi. Purchasing power, Sofi noted, is an economic term that refers to the amount of goods and services you can buy with a unit of currency, such as a dollar, after accounting for inflation.
It’s also important to understand buying power because it can help you put in place a sound trading strategy.
As Wall Street Mojo noted, with a well-planned trading strategy, investors better know how to select assets while taking several factors into consideration, such as their financial goals and their risk appetite.
How To Calculate Buying Power
As mentioned above, your buying power depends on the type of account you have. For instance, as Sofi explained, with a brokerage account or individual retirement account, this calculation is simple — just add the amount of cash you have.
“So if someone has $20,000 in cash in their brokerage account, they’d have $20,000 in buying power,” according to Sofi.
However, margin accounts generally double the amount of buying power investors hold in their accounts, Sofi added.
“So an investor who has $25,000 in a margin account would have $50,000 of stock buying power.”
What Happens When You Don’t Have Enough Buying Power?
Simply put — you just won’t be able to execute trades.
“A lack of buying power means that you lack the ability to buy,” according to Sofi. However, you can gain buying power by depositing money into your trading account.
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This article originally appeared on GOBankingRates.com: What Does Buying Power Mean for an Investor?
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