What are the Day Trading Rules?

Tue Dec 8, 2020, 04:56 pm | by Ashley Hart | No comments

If you’re looking into the world of investing, you may be wondering what day trading is. Usually, this phrase means that you’re purchasing and selling a security within the same trading day. Most day traders are active traders who are comfortable with taking on risks in the stock market. To see if day trading might be right for you, it’s important to understand what the rules are.

What is the Pattern Day Trader Rule?

First, it’s essential to understand the pattern day trading rule. A pattern day trader is a designation that is given to an investor or trader that:

  • Executes 4 or more day trader over a span of 5 business days
  • Uses a margin account to execute those day trades, and the day trades that they executed over a 5 day period makes up more than 6% of their total trade activity

If you are considered a pattern day trader, there are several rules that you should be aware of that the Financial Industry Regulatory Authority established. Your broker may have additional rules.

Minimum balance: To be a pattern day trader, you must have a minimum account balance of $25,000. To meet this requirement, you can use a combination of securities and eligible cash. However, you cannot meet this requirement by cross-guaranteeing separate accounts. 

Buying power: As a pattern trader, your day trading power will be 4 times the New York Stock Exchange (NYSE) excess at the close of business on the previous day. At this buying power, you can use the time and tick method. If you exceed the limits of your buying power, a margin call will be issued. 

Margin calls: If your account has an outstanding margin call, your buying power will go down to 2 times the NYSE excess. At this buying power, you’ll need to use the aggregate method instead of the time and tick method.

If you don’t meet a margin call within 5 days, your buying power will go down to only 1 time the NYSE excess for a period of 90 days. 

Funding: When you fund your account to meet either the minimum equity requirements or to meet margin calls, the funds have to remain in your account for at least 2 business days. You cannot make withdrawals from your account during this time.

What Counts as a Day Trade?

If you open and close (also known as buying and selling) a security position on the same day, this is considered a day trade. This may also be referred to as a “round trip” or selling short and then buying. If you’re still holding your security position after the end of the trading day, this is not considered a day trade. 

Here are some examples:

If you enter a stock position (meaning that you purchase) with an order of 2000 shares and sell those shares in 2 orders of 1000, this is considered 1 day trade.

If you purchase 2 orders of 1000 shares and then sell all 2000 shares in a single order, this is also considered 1 day trade.

However, if you purchase 2 orders of 500 shares and then sell them the same way, as two separate orders of 500 shares, this is considered two separate day trades, not 1 day trade.

Think of it this way — no matter how the shares are divided out, the transactions that you make must off-set each other for it to be considered a day trade.

How Do I Day Trade with Less Than $25,000?

You can still day trade even if you don’t have $25,000. You’ll just need to make sure that you don’t break the pattern day trader rule. 

The easiest way to day trade with less than $25,000 is to only make 3 day trades within any 5-day period. Keep in mind that these 5-day periods are rolling, not just Monday-Friday. You could also do swing trading and hold onto trades for longer than 1 day. 

If you really want to make more day trades, you could have more than 1 day trading account, each with a different broker. The downside of this is that you’ll need to split your money between the accounts, so you’ll have less money to trade with. Alternatively, you could join a day trader firm, which may be able to provide you with additional funding to trade with.

There are also riskier ways to day trade with limited funding. You could use a broker that is outside of the United States to day trade in non-U.S. markets. If you consider this route, it’s important to do plenty of research to see if the opportunities in those markets are worth your time. You may also want to consult with tax and legal professionals to fully understand the risks.

What Do I Do if I’m Flagged as a Pattern Day Trader?

If you get flagged as a pattern day trader, your broker will notify you. What happens next depends on your broker. For first-time offenders, brokers may go easy on you. In any case, the broker will probably monitor your activities a little more closely to see if you continue to day trade more than you should be.

As a result of being flagged as a day trader, some brokers may ask you to deposit enough funds to bring your account balance up to $25,000. This is known as a minimum equity call. If you’re asked to do this, your trading privileges could be suspended for 90 days until you’ve deposited the funds. Your margin buying power could also be suspended, limiting you to cash transactions. 

What Are the Benefits of Being a Pattern Day Trader

At this point, you may be wondering why anyone would want to be a pattern day trader if there are so many rules to be aware of and follow. The biggest advantage of being a pattern day trader is the leverage that it gives you. If you have a pattern day trading account, you’ll be able to trade with 4:1 leverage, which could allow you to significantly increase your profits.

However, with this extra leverage power, you’ll also face higher risks. Using leverage means that you’re borrowing money to make your trade. To trade using leverage, you only need to meet the margin requirement, which is the minimum amount you must have in cash. By trading using leverage, it is possible to lose more money than you have because you only put forth the minimum investment and borrowed the rest. If you decide to use your leverage power, you should be cautious and make sure that you can afford the losses if they occur. 

Final Thoughts

Understanding day trader rules is crucial if you want to become a successful day trader. The amount of money that you have will determine whether or not you can become a pattern day trader. You’ll also need to be familiar with risks and make informed decisions about the level of risks that you’re comfortable taking. 

At the end of the day, day trading isn’t quite as scary as it is sometimes made out to be. As long as you’re familiar with the rules and risks, you can be a responsible day trader.

Disclaimer: Benzinga is a news organization and does not provide financial advice and does not issue stock recommendations or offers to buy stock or sell any security. Benzinga Pro is for informational purposes and should not be viewed as recommendations. Benzinga Pro will never tell you whether to buy or sell a stock. It will only inform your trading decisions. You can find our full disclaimer located here.