Definition
Buying power, in finance, refers to the amount of money an investor has available to purchase securities in a trading context. It typically considers cash on hand but also includes the purchasing potential resulting from margin lending arrangements. The more buying power an investor has, the more potential profit they can realize, but it also implies more risk if the investment value decreases.
Key Takeaways
- Buying Power refers to the total amount of capital that an investor has available to buy securities in a trading context. It can also signify the financial capacity of a business or individual to make significant purchases without straining their finances.
- In margin accounts, buying power can increase due to the leverage obtained from borrowing funds for trading or due to profits made from successful trades. However, it’s important to recognize that enhanced buying power can also increase potential for losses.
- Regulations play a significant role in buying power. Different countries and trading platforms may have different regulations that can affect the buying power. For example, U.S regulations allow traders to borrow up to 50% of the purchase price of securities on margin, thus increasing their buying power.
Importance
Buying power, also known as purchasing power, is a crucial finance term as it pertains to the quantity of goods or services that one unit of a specific currency can buy.
It’s important because it sets a standard of comparison for the value and efficiency of currencies, allowing investors, economists, and financial analysts to gauge economic stability and growth.
For investors, it additionally holds relevance in the context of a brokerage account, where it defines how much stock or securities they can purchase on margin.
An increase in buying power is indicative of economic growth and individual financial capacity, while a decrease may signal inflation or potential financial distress.
Therefore, buying power serves as a significant measure of economic health and investment potential.
Explanation
Buying Power, in financial terms, serves a critical role in investment scenarios, primarily assisting investors to quantify their capacity to purchase securities without depositing additional funds. It represents the total value of securities that an investor can purchase using the current equity in their account as collateral.
Its purpose is to augment trading opportunities without necessitating an infusion of additional cash. This is particularly beneficial in margin trading where an investor can buy more securities than their available cash balance, based on their buying power.
Using Buying Power effectively helps investors achieve their financial goals and amplify their potential returns. For day-traders and swing traders, where positions often need to be entered and exited rapidly, having an accurate perspective of one’s buying power can open the door to swift decision-making and optimal trade execution.
Furthermore, adequate utilization of buying power minimizes the risk of margin calls (demands by a broker to deposit more cash or securities into the account) and consequent automatic liquidation of assets. However, while buying power can enhance trading capacity, it is essential to approach leveraged investing judiciously as resultant losses could surpass the invested capital.
Examples of Buying Power
Stock Trading: An individual with a margin account in a brokerage firm decides to buy shares of a particular company. The brokerage firm provides the individual with the ability to purchase more stocks than their actual account balance by lending them additional capital. This is known as leveraging buying power. For example, if the individual has $10,000 in their account, but the firm offers a 2:1 margin, the individual’s buying power becomes $20,
Real Estate Investing: In this sector, buying power refers to the amount a person or company can invest in property based on their available financial resources. For instance, if an individual has $200,000 in savings and is approved for a loan of $800,000 – their buying power in the real estate market becomes $1 million. They can use this to purchase properties for investment or personal use.
Retail Shopping: In the context of everyday consumer shopping, buying power refers to the capacity of a person to purchase goods based on their disposable income or budget. For example, during a holiday sale, a retailer may offer significant discounts, thus increasing the buying power of consumers. If a person had a budget of $200, and goods are discounted by 50%, their buying power effectively increases to $400 worth of goods for the same amount of money.
FAQs on Buying Power
1. What is Buying Power?
Buying power refers to the total amount of stock (in dollar terms) that you can purchase with the cash and securities in your brokerage account.
2. How is Buying Power calculated?
Buying Power is calculated as the sum of your cash balance and any unsettled funds from recent sales of stock, plus or minus any changes in the value of the stocks you own.
3. Can my Buying Power change?
Yes, your Buying Power can change due to several factors such as deposits, withdrawals, purchases and sales of stock, dividends, interest, and changes in the market value of the stocks you own.
4. What is Day-Trading Buying Power?
Day-Trading Buying Power refers to the amount that a trader has at their disposal to make trades in a single trading day. This is typically up to four times the amount of cash you have in your brokerage account, depending on the brokerage firm.
5. What happens if I exceed my Buying Power?
If you exceed your Buying Power in a margin account, you’ll need to deposit additional funds or sell stock to cover the deficiency. If you don’t, the brokerage firm could sell some or all of your securities, possibly at a significant disadvantage to you.
Related Entrepreneurship Terms
- Margin Account
- Leverage
- Equity
- Day Trading Buying Power (DTBP)
- Margin Call
Sources for More Information
- Investopedia: An extensive finance and investing online resource that includes definitions, tutorials, and articles on a wide variety of finance topics including ‘Buying Power’.
- Fidelity: A multinational financial services corporation that offers informative articles and insights related to investments and finance concepts.
- Nerdwallet: A personal finance website that provides advice, tools and guides on finance topics from credit cards to college savings plans, including ‘Buying Power’.
- Finance Zacks: An investment research website offering a good variety of finance topics and advice including detailed explanation on ‘Buying Power’.
