Do you actively trade stocks? If so, it's important to know what it means to be a "pattern day trader" because there are requirements associated with engaging in pattern day trading. Once you understand the requirements you have to meet, you reduce the risk that your firm will place restrictions on your ability to trade.
What is a day trade?
A day trade occurs when you buy and sell (or sell and buy) the same security in a margin account on the same day. The rule applies to day trading in any security, including options.
Who is a pattern day trader?
According to FINRA rules, you are considered a pattern day trader if you execute four or more "day trades" within five business days — provided that the number of day trades represents more than 6% of your total trades in the margin account for that same five business day period.
The rules also require your firm to designate you a pattern day trader if it knows or has a reasonable basis to believe that you will engage in pattern day trading. For example, if the firm provided day-trading training to you before opening your account, it could designate you as a pattern day trader.
What are the requirements for pattern day traders?
First, pattern day traders must maintain minimum equity of $25,000 in their margin accounts. This required minimum equity must be in your account prior to engaging in any day-trading activities. For more information on these margin requirements, read this: Day-Trading Margin Requirements: Know the Rules.
In addition, pattern day traders cannot trade in excess of their "day-trading buying power," which is defined in FINRA's rules (generally up to four times an amount known as the maintenance margin excess as of the close of business of the prior day). Maintenance margin excess means the amount by which the equity in the margin account exceeds the required margin. So if the equity in your account totals $30,000, you would have $25,000 maintenance margin requirement and your maintenance excess is $5,000.
Why do I have to maintain minimum equity of $25,000?
Day trading can be extremely risky. FINRA determined that brokerage firms have a risk associated with investors' day-trading activities, so these requirements provide firms with a cushion to meet any deficiencies in the investor's account resulting from day trading. In fact, firms are free to impose a higher equity requirement than the minimum specified in the rules, and many of them do. These higher minimum requirements are often referred to as "house" requirements.
Is pattern day trading right for you?
Before you come to any conclusion, read and consider the points set forth in the Day-Trading Risk Disclosure Statement embodied in FINRA Rule 2270. In addition to minimum equity requirements, day trading requires knowledge of both securities markets in general and, more specifically, your firm's business practices, including the operation of the firm's order execution systems and procedures.
Day trading generally is not appropriate for someone of limited resources, limited investment or trading experience, and low risk tolerance. A day trader should be prepared to lose all of the funds used for day trading. Given the risks, day-trading activities should not be funded with retirement savings, student loans, second mortgages, emergency funds, assets set aside for purposes such as education or home ownership, or funds required to meet living expenses.
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