Details of the restrictions imposed by the Securities and Exchange Commission (SEC) on day trading of stocks and stock markets in the United States. These restrictions define “pattern day traders” and require them to maintain a minimum equity balance of $25,000 in their trading account. In other words, to engage in regular day trading of stocks in the United States, you need at least $25,000 of your own capital in your trading account. Continue reading to learn more about when a trader becomes a day trader and what the requirements are once they acquire this classification.
Pattern Day Trading
The Securities and Exchange Commission (SEC) defines day trading as any transaction that is opened and closed on the same trading day. This can be a buy and sell or a short sell executed through a buy order. If you make four or more day trades within five trading days, the SEC is likely to consider you a day trader.
The only exception to this rule is if the total number of day trades does not exceed 6% of your overall trades during that time frame. You are considered a day trader only if four or more day trades account for more than 6% of your trading activity. However, unless you are a highly active swing trader, four day trades in a week will classify you as a pattern day trader.
Note: Even if you make only one trade per day, that may classify you as a pattern day trader, and you will be expected to meet the minimum equity requirements.
Check Your Broker’s Requirements
The Securities and Exchange Commission (SEC) sets the minimum requirements for day traders in the United States. Individual brokerage firms may have stricter definitions, so it is important to research the details of what your broker expects from pattern day traders.
For example, a broker may define day trading as executing two or three day trades in a five-day period instead of four. In other cases, the broker may count certain stocks and ETFs towards minimum equity requirements but not count low-value stocks or options. By researching your broker’s exact requirements, you can avoid issues and maintain your account’s eligibility for day trading.
Trading Suspension
If a trader is classified as a pattern day trader — either by the Securities and Exchange Commission (SEC) or at the broker’s discretion — they will be expected to maintain the equity balance requirements (at least $25,000). If the trader does not have the required equity balance of $25,000 in their account, they will be prohibited from making further day trades.
Day trading will remain unavailable until the equity balance in the account is increased to $25,000. Day traders only need to maintain the $25,000 balance on the days they are engaged in day trading.
Note: It is important to consider any swing or long-term positions in your account while day trading. If you are busy with day trading and unaware that your other investments are losing value, you may find yourself below the equity requirements without realizing it.
Leverage or Margin
Day traders in the United States are allowed to use leverage up to 4 to 1. This means that if a day trader deposits $30,000 in their account, they can accumulate positions of up to $120,000. Only traders who hold positions overnight are allowed to use leverage up to 2 to 1.
Allowed
For day traders to obtain greater leverage, as their positions are short-term, and thus, each trade is likely to experience smaller price fluctuations than positions held for days, weeks, or years.
If a trader exceeds the allowable margin (for example, if a losing position causes a decrease in their deposited capital), a margin call will be issued.
Alternatives to Minimum Equity Requirements
The $25,000 minimum equity restriction applies only to U.S. stock markets. Day trading restrictions vary in other markets. There are no minimum equity balance requirements for trading futures and currencies in the United States, but brokerage firms may set minimum deposit and margin requirements for each asset. The same applies to cryptocurrencies like Bitcoin.
Note: If a trader has at least a $25,000 equity balance, all markets – including the stock market – are tradable options.
Day traders with less than $25,000 in capital need to obtain additional capital to trade in the stock market. Alternatively, they can participate in futures, forex, or cryptocurrency markets, which are also considered day trading markets.
Although there are no legal requirements, a trader may want to ensure that they have starting capital of at least $5,000 to $7,500 (preferably more) before trading in futures. For forex trading, a trader may want to have at least $500 in starting trading capital (preferably $1,000 or more).
Frequently Asked Questions (FAQs)
What happens if I violate the Pattern Day Trading rules?
When your minimum equity balance for day trading falls below $25,000, you will not be allowed to trade until you deposit more into your account. If you exceed your current margin, your broker will issue a margin call, giving you five days to deposit enough to cover the trade. If you do not meet this margin call by the deadline, your margin will begin to decrease.
What is the basis behind the Pattern Day Trading rules?
These rules were implemented by FINRA, the Financial Industry Regulatory Authority, after surveying brokerage firms to determine the necessary cushion to hedge against the risks associated with day trading. These rules are only the minimum. Some firms impose stricter restrictions on day traders.
Sources:
Office of Investor Education and Advocacy. “Margin Rules for Day Trading.”
Financial Industry Regulatory Authority. “Margin Requirements for Day Trading: Know the Rules.”
TD Ameritrade. “Pattern Day Trading.”
CME Group. “Benefits of Trading Futures.”
FINRA. “Margin Requirements for Day Trading: Know the Rules.”
Source: https://www.thebalancemoney.com/day-trading-restrictions-on-us-stocks-1031352
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