Pattern day trader: Difference between revisions

Revision as of 01:57, 4 March 2020

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'''Pattern day trader''' is a [[FINRA]] designation for a [[stock market]] [[Stock trader|trader]] who executes four or more [[day trades]] in five business days in a [[margin account]], provided the number of day trades are more than six percent of the customer's total trading activity for that same five-day period.<ref name="ref1" />

A FINRA rule applies to any customer who buys and sells a particular security in the same trading day (day trades), and does this four or more times in any five consecutive business day period; the rule applies to margin accounts, but not to cash accounts. A pattern day trader is subject to special rules. The main rule is that in order to engage in pattern day trading you must maintain an equity balance of at least $25,000 in a margin account. The required minimum equity must be in the account prior to any daytrading[[day trading]] activities. Three months must pass without a day trade for a person so classified to lose the restrictions imposed on them. Pursuant to NYSE 432, [[brokerage firm]]s must maintain a daily record of required margin.

The minimum equity requirement in FINRA Rule 4210 was approved by the [[Securities and Exchange Commission]] (SEC) on February 27, 2001 by approving amendments to NASD Rule 2520.<ref name="ref2" />

<ref name="ref2" />

==Definition==

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==Round trip==

A '''round trip''' is the purchase and subsequent sale of forementioned purchased (stocks)[[equities]].

Day trading refers to buying and then selling or selling short and then buying back the same security on the same day.<ref name="ref7" /> Interpretation for more complex situations may be subject to interpretation by an individual brokerage firm. For example, if you buy the same stock in three trades on the same day, and sell them all in one trade, that can be considered one day trade<ref name="ref8" /> or three day trades.<ref name="ref9" /> If you buy stock in one trade and sell the position in three trades, that is generally considered as one day trade if all trades are done on the same day. Three more day trades in the next four business days will subject your account to restrictions (you can only close existing positions or purchase with available cash up front) for 90 days, or until you deposit enough to have $25,000 in your account, whichever comes first. Day trading also applies to trading in option contracts. Forced sales of [[securities]] through a [[margin call]] count towards the day trading calculation.

==Requirements and restrictions==

Under the rules of [[NYSE]] and [[Financial Industry Regulatory Authority]], a [[traderTrader (finance)|trader]] who is deemed to be exhibiting a pattern of day trading is subject to the "Pattern Day Trader" rules and restrictions and is treated differently than a [[trader (finance)|trader]] that holds positions overnight. In order to day trade:<ref name="ref3" />

* '''Day trading minimum equity''': the account must maintain at least USD25USD $25,000 worth of [[Ownership equity|equity]].

* '''Margin call to meet minimum equity''': A day trading minimum equity call is issued when the pattern day trader account falls below $25,000. This minimum must be restored by means of cash deposit or other marginable [[equities]].

** '''Deadline to meet calls''': Pattern day traders are allowed to deposit funds within five business days to meet the margin call

** '''Non-withdrawal deposit requirement''': This minimum [[Ownership equity|equity]] or deposits of funds must remain in the account and cannot be withdrawn for at least two business days.

** '''Cross guarantees are prohibited''': Pattern day traders are prohibited from utilizing cross guarantees to meet day-trading margin calls or to meet minimum equity requirements. Each day trading account is required to meet all margin requirements independently, using only the funds available in the account.

* '''Restrictions on accounts with unmet day trading calls''': if the day trading call is not met, the account's [[day trading]] buying power will be restricted for 90 days or until day trading minimum equity [margin call is met].

[[equities]]

==Day trading buying power==

The rule provides day trading buying power to up to 4 times a pattern day trader's maintenance margin excess. The excess maintenance margin is the difference of the account equity and the margin requirement. For example, if a trader has $100,000 worth of [[equities]] with no margin loan, the [[leverage (finance)|leverage]] ratio is 4:1, meaning that it can buy [[securities]] of up to $400,000. 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.

For day trading in equity securities, the day trading margin requirement shall be 25% of either:

# the cost of all day trades made during the day; or

# the highest open position during the day.

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.

==Day trading in cash accounts==

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. Under Regulation T, brokers must “freeze”"freeze" an investor’sinvestor's account for 90 days if he/ or she sells securities that have not been fully paid (i.e., paid for with unavailable funds). During this 90-day period, the investor must fully pay for any purchase on the date of the trade.<ref name="ref10" />

==History==

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{{POV section|date=December 2019}}

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.

The SEC believes that people whose account equity is less than $25,000 may represent less-sophisticated traders, who may be less able to handle the losses that may be associated with day trades. This is along a similar line of reasoning that [[hedge fund]] investors typically must have a net worth in excess of $1 million. 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 poorer 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.