What is Cash Trading?
Cash trading is an investment strategy that calls for the investor to make purchases of securities on a cash basis only. This is different from the process of trading on margin, where the investor makes use of a line of credit extended through a broker. With the cash trading method, the investor relies solely on the balance of his or her cash account to purchase stocks, bonds, commodities or other investment vehicles.
Many investors utilize what is known as a margin account as a means of conducting trades on various markets. Typically, a brokerage will work with an investor to establish an account of this type based on the total assets held by the investor, and his or her general credit worthiness. This approach allows investors to make use of margin trading to acquire securities without making immediate use of all available cash reserves. In the event that those purchased assets lose money rather than earning a return, the investor is responsible for covering the debt out of his or her assets.
In contrast, an investor who utilizes a cash trading strategy does not have to be concerned with the possibility of incurring a great deal of debt due to securities purchased on margin. Since the securities are paid for in full at the time of purchase, the investor is free to hold those assets for any amount of time he or she wishes. In the event that the investor needs ready cash to purchase more securities, it is possible to identify holdings within the portfolio that are not performing up to expectations, sell those holdings, and use the cash generated from the sale to acquire securities that show more promise.
Opinions on the practicality of cash trading vary. Some investors as well as brokers do not encourage this approach, since trading on cash only can limit the investment opportunities that can be pursued concurrently. This effectively minimizes the potential for the investor to earn the most return from his or her investment activity. Proponents of the cash trading approach note that this strategy inherently carries less risk than trading on margin, since even if the acquired securities do not perform as anticipated, the amount of the loss is limited and will not result in the creation of a huge debt obligation. Many investors tend to utilize a combination of the two strategies, operating primarily with the use of cash to acquire securities, while trading on margin when cash reserves are temporarily low.
I use a cash account and a margin account for two different styles of trading.
If I plan on buying a stock I want to hold on to for the long term, I will usually use a cash account for this trade. It usually depends on the volume and volatility of the stock.
I use my margin account for quick trades when I plan to be in and out of the trade in a very short time.
I know there is risk with a margin account, but I always have limits set, so I control my losses this way.
My cash account usually grows slower and gradually, where my margin account usually has much bigger fluctuations along the way.
I have been burned using margin accounts more than once. I finally learned my lesson, and closed my margin accounts and now just use a cash trading account.
Trading stocks always has its risk, and if you don't know what you are doing, having a margin account can really go against you in a hurry.
If you get a margin call and can't come up with the extra money, you can end up in a real bind. Even though I felt like I was conservative with my trades, I just didn't need the extra pressure.
I was lured into thinking I could make so much more money because I had twice as much to trade with. You also have twice as much at risk because 100% of the money is not yours.
Now all of my online share trading is done with a cash account. This is something I feel is more conservative and fits better with my comfort level.
I have both cash and margin investment accounts, and there are definite advantages and disadvantages to each of them.
In my IRA accounts, these have to be cash accounts, as you can't trade on margin with this money. If I am going to buy stock in an IRA account, I know exactly what I am working with. I don't have to worry about getting a margin or maintenance call if the stock doesn't perform the way I think it will.
While you are more limited to the funds you have to trade with, a cash account certainly takes some pressure off. If the stock goes the opposite direction you anticipate, you may lose some money, but at least you are trading with cash and not money that the brokerage company has loaned to you.
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