Brokerage rules for day trading
If the account has a margin loan, the day trading buying power is equal to four times the difference of the account equity and the current margin requirement. If a client's day trading margin requirement is to be calculated based on the latter method, the brokerage must maintain adequate time and tick records documenting the sequence in which each day trade is completed. Time and tick information provided by the customer is not acceptable. The Pattern Day Trading rule regulates the use of margin and is defined only for margin accounts.
Cash accounts, by definition, do not borrow on margin, so day trading is subject to separate rules regarding Cash Accounts. Cash account holders may still engage in certain day trades, as long as the activity does not result in free riding , which is the sale of securities bought with unsettled funds.
An instance of free-riding will cause a cash account to be restricted for 90 days to purchasing securities with cash up front. During this day period, the investor must fully pay for any purchase on the date of the trade. Requirements for the entry of day trading orders by means of "pattern day trader" amendments: While all investments have some inherent level of risk, day trading is considered by the SEC to have significantly higher risk than buy and hold strategies.
The Securities and Exchange Commission SEC approved amendments to self-regulatory organization rules to address the intra-day risks associated with customers conducting day trading. The rule amendments require that equity and maintenance margin be deposited and maintained in customer accounts that engage in a pattern of day trading in amounts sufficient to support the risks associated with such trading activities.
In other words, the SEC uses the account size of the trader as a measure of the sophistication of the trader. This rule essentially works to restrict less sophisticated traders from day trading by disabling the traders ability to continue to engage in day trading activities unless they have sufficient assets on deposit in the account.
On the other hand, some argue that it is problematic not because it is some sort of unfair over-regulatory attack on the "free market," but because it is a rule that shuts out the vast majority of the American public from taking advantage of an excellent way to grow wealth.
Another argument made by opponents, is that the rule may, in some circumstances, increase a trader's risk. For example, a trader may use 3 day trades, and then enter a fourth position to hold overnight. If unexpected news causes the security to rapidly decrease in price, the trader is presented with two choices. One choice would be to continue to hold the stock overnight, and risk a large loss of capital.
The other choice would be to close the position, protecting his capital, and perhaps inappropriately fall under the day-trading rule, as this would now be a 4th day trade within the period. Of course, if the trader is aware of this well-known rule, he should not open the 4th position unless he or she intends to hold it overnight. However, even trades made within the three trade limit the 4th being the one that would send the trader over the Pattern Day Trader threshold are arguably going to involve higher risk, as the trader has an incentive to hold longer than he or she might if they were afforded the freedom to exit a position and reenter at a later time.
In this sense, a strong argument can be made that the rule inadvertently increases the trader's likelihood of incurring extra risk to make his trades "fit" within his or her allotted three-day trades per 5 days unless the investor has substantial capital. The rule may also adversely affect position traders by preventing them from setting stops on the first day they enter positions.
For example, a position trader may take four positions in four different stocks. To protect his capital, he may set stop orders on each position. The brokerage firm is the lender and the customer is the borrower. No, you can't use a cross-guarantee to meet any of the day-trading margin requirements.
Each day-trading account is required to meet the minimum equity requirement independently, using only the financial resources available in the account.
What happens if the equity in my account falls below the minimum equity requirement? I'm always flat at the end of the day. Why do I have to fund my account at all? Why can't I just trade stocks, have the brokerage firm mail me a check for my profits or, if I lose money, I'll mail the firm a check for my losses? It is saying you should be able to trade solely on the firm's money without putting up any of your own funds. This type of activity is prohibited, as it would put your firm and indeed the U.
The money must be in the brokerage account because that is where the trading and risk is occurring. These funds are required to support the risks associated with day-trading activities. You can trade up to four times your maintenance margin excess as of the close of business of the previous day. You should contact your brokerage firm to obtain more information on whether it imposes more stringent margin requirements. If you exceed your day-trading buying power limitations, your brokerage firm will issue a day-trading margin call to you.
Until the margin call is met, your day-trading account will be restricted to day-trading buying power of only two times maintenance margin excess based on your daily total trading commitment. Day trading in a cash account is generally prohibited. Day trades can occur in a cash account only to the extent the trades do not violate the free-riding prohibition of Federal Reserve Board's Regulation T.
In general, failing to pay for a security before you sell the security in a cash account violates the free-riding prohibition. If you free-ride, your broker is required to place a day freeze on the account. No, the rule applies to all day trades, whether you use leverage margin or not.
For example, many options contracts require that you pay for the option in full. As such, there is no leverage used to purchase the options. Nonetheless, if you engage in numerous options transactions during the day you are still subject to intra-day risk. You may not be able to realize the profit on the transaction that you had hoped for and may indeed incur substantial loss due to a pattern of day-trading options.
Again, the day-trading margin rule is designed to require that funds be in the account where the trading and risk is occurring.
Can I withdraw funds that I use to meet the minimum equity requirement or day-trading margin call immediately after they are deposited? No, any funds used to meet the day-trading minimum equity requirement or to meet any day-trading margin calls must remain in your account for two business days following the close of business on any day when the deposit is required.
Frequently Asked Questions Why the change? Were investors given an opportunity to comment on the rules? Definitions What is a day trade? Does the rule affect short sales? Does the rule apply to day-trading options? The day-trading margin rule applies to day trading in any security, including options. What is a pattern day trader? Day-Trading Minimum Equity Requirement What is the minimum equity requirement for a pattern day trader?