Cash trading involves purchasing securities with cash only, while margin trading involves using a line of credit extended through a broker. Cash trading carries less risk, but limits investment opportunities. Many investors use a combination of both strategies.
Cash trading is an investment strategy that requires the investor to make purchases of securities with cash only. This is different from the process of trading on margin, where the investor uses a line of credit extended through a broker. With the cash method of trading, the investor relies solely on his or her cash account balance to purchase stocks, bonds, products, or other investment vehicles.
Many investors use what is known as a margin account as a means to trade various markets. Typically, a brokerage will work with an investor to establish such an account based on the total assets held by the investor and the investor’s overall creditworthiness. This approach allows investors to use the markup to purchase securities without making immediate use of all available cash reserves. In the event those purchased assets lose money instead of earning a return, the investor is responsible for covering the debt on their assets.
In contrast, an investor using a cash trading strategy does not have to worry about the possibility of incurring a large amount of debt due to securities purchased on margin. Since the securities are paid in full at the time of purchase, the investor is free to hold these assets for as long as he wishes. In the event that the investor needs ready cash to buy more securities, it is possible to identify holdings within the portfolio that are not meeting expectations, sell those holdings, and use the cash generated from the sale to purchase securities that show more promise. .
Opinions on the practicality of cash trading vary. Some investors, as well as brokers, do not encourage this approach, as cash only trading can limit the investment opportunities that can be pursued simultaneously. This effectively minimizes the potential for the investor to obtain the highest return from his investment activity. Proponents of the cash-trading approach point out that this strategy carries less risk than trading on margin, because even if the purchased securities do not perform as expected, the amount of loss is limited and will not create a large debt obligation. Many investors tend to use a combination of the two strategies, trading primarily using cash to purchase securities, while trading on margin when cash reserves are temporarily low.
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