What is a Trading Account?
Before opening a trading account you need to know what it is. A trading account is used as a way for an investor to purchase stocks or more generally a financial asset like cash, securities and a lot of different types of investments. A trading account is traditionally held by a financial institution and managed by a broker that do run a trading strategy for the account holder. With the arrival of digital things have changed and of course you can now have an online trading account with an online broker that will work as the investment dealer.
When you are about to open a new trading account there are a number of things you would need to consider like ‘What type of account should I open? Should I fund it from my bank account?’ and so on.
It is also important to understand that every online broker is different and the sign up process is not always the same. In this article we have however given you some guidance based on the common patterns we see across the different brokers.
“Should I fund it from my own bank account?” Yes you should. The account will be in your name so you cannot use for example a check from a friend to put money into the newly created trading account. The most common and safe way is to do a bank transfer directly from you bank into your newly created online broker trading account.
The type of account will really depend both from the type of trading that you are planning to do, the capital that you are ready to invest and ultimately the broker that you will choose.
Types of Trading Accounts: Margin vs. Cash Accounts
An important thing to decide is if you are going to use a cash or margin trading account. But let’s take a look at what are the differences between the two.
Margin Trading Account
A margin account means that . you get a line of credit from your online broker and this allows you to buy stocks or other financial instruments and options if you like. It is important to know that trading options is complicated and should be done by very experienced investors that have big capitals at their disposals.
Cash Trading Account
A cash account means that you can place trades by using only the money that are in your account. So if you place £10,000 in your account than the maximum you will be able to spend is £10,000. Until you will close a position you will not be able to buy more. So in a cash account you won’t be allowed to borrow money so the strategy to use will have to be in line with the funding available.
What is Margin?
The majority of online brokers will offer you some margin in the trading account. By doing so they are giving you effectively more money to trade additional financial instruments. It is important to notice that when you borrow some money there will always be some costs associated with it. You will need to be comfortable of those costs to avoid that those will impact your profit line. Also, it is important to say that you are responsible to pay those money back regardless if you are successful or not in your trading. Surely by investing more money you can increase the profits if things will go in the right way but if the market move against you, you might lost more money than you have put in initially.
The margin will be set up in your online broker trading account and if it is at 2:1 it means that if you open an account with £10,000 you will be able to trade up to £20,000 in financial assets. Most online brokers nowadays do offer you a 4:1 leverage if you deposit more than £25,000. Normally those are only for intraday use so it means that you must maintain 50% overnight.
Intraday Margin PDT
Let’s look into more details into the Intraday Margin which is also called Pattern Day Trader Margin or PDT. So let’s consider you had £25,000 or more in your account and you will be able to get a 4:1 leverage with your broker. So in this case you will be allowed to purchase financial assets worth £100,000 or more. This is intraday so overnight the margin may only be 50%. If you decide to invest all you have than you can go for a maximum of £100,000 but you would have to close at least a part of that trade by the end of the day.
Your Personal Information
When you are in the process of opening a trading account the online broker will need to have enough information about you. The information is normally needed for verification, account handling, tax tracking and others. Depending on which countries you are the documents needed might be different. It is important that investors will always provide accurate personal information. The online broker might need to contact you to discuss changes in your account or to provide support.
What is Required to Open a Trading Account?
Online brokers do have strict policies regarding your privacy and your information will be handled with total care. It is important when you have decided which online broker to go for that you spend some time to familiarise yourself with the rules of the company and how they are going to handle they information. Normally this is what an online broker is likely to require from you:
Your full name, street address, phone number, e-mail address, date of birth, place of employment, approximate annual income, net worth with or without your home and any previous market experience.
Those are required as standard and also because it is important for them to know who they are working with. It is important to answer everything honestly and also be prepared on how to answer some questions: for example a lot of people do not realise that their net worth includes things like television sets and automobiles. They always think that is just their positions and account but it does go beyond this and it is the market value of the things we own if they would be for sale. The same goes for market experience: answering by saying that you have a zero market experience might not be correct if you have traded stocks before even if it was long time ago and with a different brokers.
Providing incorrect information might lead in you being exposed to more risk and therefore losing more than you can afford. This is why it is important to treat the chosen online broker as a partner and share with them all the correct information so that you can increase the chances of being successful.
In addition to the standard questions that an online broker will ask you when signing up there will also be additional information they might ask you. For example they might ask if you have been a director or if you own shares already from publicly owned companies and so on. Again those information will be important for them to profile you better so be honest and transparent.
How to Fund a Trading Account?
We touched before briefly on that topic so let’s go into a bit more details on it. The best way to fund your online trading account is to do a bank transfer from your bank account. Alternatively most brokers do accept a check as long as it has your name of it. Most online broker will have a minimum deposit requirement to open a new account. In the past this used to be higher but with the increase competition online brokers have been pushed to lower the minimum deposit and also offer some interesting leverage.
Determining Your Suitability to Open an online Trading Account
So all the information you will provide to the online broker will help them to determine your suitability to have a trading account. Online brokers have a rule which is called ‘Know Your Customer’: this is helpful for them to determine the investor’s ability in handling risks. Normally this is divided in 4 basic concepts:
- 1. Aggressive growth – this means that you are prepared to take some extra risks in order to increase your profit. You will be therefore tempted to trade in more volatile markets.
- 2. Simple growth – here you will be keen to gain money in the account but you want to preserve the original investment as much as possible. In this scenario you might want to say that you are prepared to get a level of risk but you don’t want to lose more than 5% of your initial capital. If that happen you are happy to stop-loss.
- 3.Income – in this case you are planning to use the profits from the trade as a source of income. In this case you will be taking out a small amount at the end of the month so that your account will basically remain the same and that everything you have made will come to you as a income.
- 4. Capital Preservation – this is the most conservative one and it is when investors are willing to trade just to save and protect existing assets.
Once you will provide all your details than you can discuss with your online broker account manager what will be the best strategy to accomplish your aim. This is the best way to approach online trading and will significantly reduce the risk of incurring in massive losses and disappointments down the line.