When opening a brokerage account for the first time, many new traders click quickly through the fine print and risk disclosures. I must confess that I did the same thing the first time I opened an account. I must warn you … this type of cursory review is not the best idea. I have seen many new traders get tripped up on certain rules and regulations that they didn’t realize existed. Unfortunately, ignorance is never a solid defense for the legal system. Specifically, I want to discuss some of aspects of day-trading rules so you are better informed.
First, I suggest everyone should actually read the risk statements and disclosures that they perhaps skimmed through in the past. Part of the agreement your broker had you sign when you first opened your account is an acknowledgment that you have read and understand what is written there.
Understanding the rules surrounding day trading is of immediate importance. Day trading is the common term for the act of rapidly buying and selling stocks throughout the day in the hopes of making small increments of money during the minutes or seconds the trade is held. Day trading is not illegal or unethical and this type of trading may seem appealing as this strategy, by definition, does not hold any stock (or risk) overnight. Most individual investors, however, do not have the capital, time, or discipline to consistently make money this way. The Financial Industry Regulatory Authority (FINRA) has established rules to protect individual investors by limiting the types of accounts that can engage in day trading.
Day Trade Minimums
First and foremost you must to have a margin account to day trade. Cash accounts can theoretically day trade but they need to wait for the sale to settle before using those funds again. (3 days for stock, 1 day for options) In a margin account, you must maintain an account balance of $25,000 to engage in pattern day trading. FINRA flags any account with four day trades within a five-day period as a “Pattern Day-Trader.” If the account value closes below $25,000, the account will be restricted to closing orders only until the value increases above $25,000. There is one reset that FINRA allows every 90 days for day trade accounts which fall below the $25,000 minimum threshold, which removes the margin call without bringing in additional funds. However you cannot trade more than three day trades in a 5 day period until the account value closes above $25,000 once again.
Day Trading Buying Power
Your account’s day trading buying power is another aspect of day trading that needs to be fully understood. These rules apply to all margin accounts regardless of account value as well as cash accounts. Traders should make a habit of writing down the buying power of their account at the start of every trading day in their trade notebook.
Again, according to FINRA rule, the largest open day trading positions cannot exceed this start-of-day buying power. Any deposits or proceeds from closing an overnight position cannot be used for day trading until the next business day. For example, if your account’s buying power before the market opens is $12,000, this is the largest open day trade position you can have. If you sell an existing $20,000 stock position that you had in your account, the buying power you see on your platform may now show greater than $12,000 in buying power. You can use this buying power for another trade, but that trade cannot be closed that same day (it must be held overnight). If it is closed the same day, that closing day trade will generate a day-trading margin call. This is different than a regular margin call because a day-trading margin call requires that new funds be added to the account.
Failure to meet a day-trading margin call will result in a day-trading restriction regardless of account value. This means you cannot day trade using margin and the account will remain on aggregation for 90 days or until the day trade margin call is met.
Even more punitive is if another day-trade margin call is generated within that 90-day period. At this point, the account will be restricted to closing transactions only for 90 days or until the call is met with new funds deposited to the account. This is not intended to scare anyone but rather to make sure traders are informed of the day-trading rules mandated by FINRA. Visit FINRA’s home page where they have more information on day trading risk and rules.
These rules regarding day trading can get quite confusing so be sure you are aware of the rules before you trade! Further examples are given in the OptionsHouse frequently asked questions tab (FAQ) within the margin section.
Additionally, a direct link to the Risk Statements and Disclosures site is located at the bottom center of the OptionsHouse trading platform. And finally, here is a link to the pattern day trading disclosure site.
Photo Credit: The Cleveland Kid
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Tags: Account Requirements, Buying Power, Day Trading, FINRA, Managing Risk, Margin Requirements, OptionsHouse
