How Is Stock Buying Power Calculated?

By Business & Finance Last updated Sunday, May/19/2024

Definition of Buying Power

There are two different types of buying power. In a cash account, it's the money you have to buy stocks. The second type of account is a margin account. The margin account also allows you to use the value of the stocks you already own as a way to borrow money to purchase additional stocks and is calculated into the definition of buying power. The margin equals the value of the stock minus the loan from the broker, divided by the value of the stock. If you buy a stock that costs $100 and borrow $50 from your broker, it would leave $50 divided by $100 or 50 percent.

In a margin account, you use a loan from the broker to buy the stock. The lowest an initial margin can go is 50 percent, as set by the Federal Reserve Board. Once you purchase the stock, each brokerage sets how low the stock can go before you must pay some of the margin loan. The New York Stock Exchange says it's 25 percent, but brokerage houses can set higher maintenance amounts. You can't buy some stocks on a margin. Many times, you can't purchase stocks that cost under $3 on a margin. Some securities like government bonds require a smaller margin percentage. In the case of government bonds, you may only need 10 percent of the value. You pay interest to the brokerage house on the money you borrow.

When you calculate the buying power, you use any excess value of the stocks, bonds and other investments above the requirement. For example, if you have a loan of $5,000 and stocks that value $30,000, you can use some of the excess equity in your account. If the margin requirement is 30 percent, that means you must have at least $9,000 without a loan. This leaves $21,000 to use. You already have a loan of $5,000, so the money you have available is $16,000. This is your excess value. You can use the $16,000 to buy $32,000 worth of stock. Remember, you have a 50 percent requirement to buy.

Bonds are better. Because bonds have a face value that eventually pays in full, they're less risky than stocks in some ways. Most brokerage houses lend you as much as 80 percent of the amount of the bond and require a maintenance of as little as 5 to 6 percent. You can use the value of a bond you bought for cash also. If your bond is worth $95,000, often you can use as much as 95 percent of its value to include in your excess value amount and buy more securities.

If you're buying stock, just calculate the excess value plus your cash and multiply it by 2 because you need 50 percent to purchase on a margin to get your buying power. This is a wonderful way to purchase securities when the market rises; it's also extremely risky. If the market drops suddenly, you need the cash to cover any money that drops below the maintenance margin.