What is Pattern Day Trading?
Pattern Day Trading - Day Trading Rules
The key day trading rule maintain a minimum account of $25,000.
Each client day trader moves from paper trading (day trading with a simulator - first trading only 100 shares to learn the software, then 500 shares with emotion, then 1,000 shares with more emotion, all the while doing what's needed to gain experience daytrading new school) to cash.
For beginners going cash, I recommend a trading account balance of $50,000. Trading on the edge of $25,000 is not even close to the comfort zone you need for learning. Remember, traders first need to learn to lose. That's why we limit lot size to 100 shares per stock trade. Then traders learn to win, then consistently win, here with 500 share lot size, then consistently and very profitably win with 1,000 shares a day trade.
As you progress from 100 shares, to 500 shares, then 1,000 shares a day trade, you will want a trading account of $100,000 to have buying power with stocks of all price levels.
Day Trading Trading Day by Day GOOGLE
When you "do a Google" (Google Adwords keyword search), the terms with the most global and monthly clicks pattern day trading and day trading rules are: pattern day trading, day trading rules, daytrading rules, day trader rule, day trader rules, pattern day traders, pattern day trader, pattern day trade, day trade rules.
Day Trading Day Trade more INFO
Below I have excerpted definitions and other day trading rules from three authority websites as they relate to pattern day traders for your additional information.
Notice the terms being searched - day trading rules, daytrading rules, day trader rule, day trader rules, pattern day traders, pattern day trader, pattern day trade, day trade rules - are not the terms you find in the descriptions provided by these information sites. This may be the disconnect between what we think we know and what we need to know that when bridged with this information allows us to play by the rules of the game of day trading stock.
From Wikipedia, the free encyclopedia.
http://en.wikipedia.org/wiki/Pattern_day_trader
Pattern Day Trader
Pattern day trader is a term defined by the U.S. Securities and Exchange Commission to describe a stock market trader who executes 4 (or more) day trades in 5 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. As the trader is exposed to the danger of day trading and intraday risks and potential rewards, it is subject to specific requirements and restrictions.
Basic Summary
A FINRA (NASD) rule that 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, 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 activities.
Brokerage firms are not required under the rule to monitor the minimum equity requirements on an intra-day basis. Three months must pass without a day trade for a person so classified to lose the restrictions imposed on them.
Rule 2520, the minimum equity requirement rule was passed on February 27, 2001 by the Securities and Exchange Commission (SEC) approving amendments to National Association of Securities Dealers, Inc. (NASD).
Definition
A pattern day trader is defined in Exchange Rule 431 (Margin Requirement) as any customer who executes 4 or more round-trip day trades within any 5 successive business days.
If, however, the number of day-trades is less than or equal to 6% of the total number of trades that trader has made for that five business day period, the trader will not be considered a pattern day trader and they will not be required to meet the criteria for a pattern day trader.
A non-pattern day trader (i.e. someone with only occasional day trading), can become designated a pattern day trader anytime if they meet the above criteria.
If the brokerage knows, or reasonably believes a client who seeks to open or resume an account will engage in pattern day trading, then the customer must immediately be considered a pattern day trader without waiting 5 business days.
Source: Information Memo of Amendments to Rule 431 ("Margin Requirements") Regarding "Day Trading"
Requirements and Restrictions
Under the rules of NYSE and Financial Industry Regulatory Authority, a trader who is deemed to be exhibiting a pattern of day trading will be subject to the "Pattern Day Trader" laws and restrictions, which is treated differently from a normal trader. In order to day trade:
Day trading minimum equity: the account must maintain at least US$25,000 worth of equity.
Margin call to meet minimum equity: A day trading minimum equity request is called when the pattern daytrader account falls below US$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 5 business days to meet the margin call
Non-withdrawal deposit requirement: This minimum equity or deposits of funds must remain in the account and cannot be withdrawn for at least 2 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 now required to meet all margin requirements independently, using only the funds available in the account.
Restrictions on accounts with unmet calls: if the call is not met, the account's day trading buying power will be frozen for 90 days or until day trading minimum equity margin call is met again.
Day Trading Buying Power
The rule increases day trading buying power to up to 4 times a pattern day trader's maintenance margin excess. For example, if a trader has $100,000 worth of equities, the leverage ratio is 4:1 meaning that it can buy securities of up to $400,000.
For day trading in equity securities, the day trading margin requirement shall be 25% of either:
1. the cost of all day trades made during the day; or
2. 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.
History
NASDAQ further restrict the entry by means of "pattern day trader" amendments. On February 27, 2001, the Securities and Exchange Commission (SEC) approved amendments to National Association of Securities Dealers, Inc. (NASD) Rule 2520 traders. The NASD amendments to Rule 2520 become effective on September 28, 2001, while the NYSE amendments to Rule 431, which are substantially similar, information memo from NYSE became effective August 27, 2001.
Rationale
While all investments have some inherent level of risk, day trading is considered by the SEC to have significantly high risk. The Securities and Exchange Commission (SEC) makes new amendments to address the intraday risks associated with day trading in customer accounts. The 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.
In addition, the SEC believes that people whose account sizes are less than $25,000 may represent less sophisticated traders, who may be more prone to being misled by advisory brokers and/or tipping agencies. 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 relating to margin requirements for day of the trader as a measure of the sophistication of the trader.
One argument made by opponents of the rule is that the requirement is "governmental paternalism" and anti-competitive in a sense that it puts the government in the position of protecting investors/traders from themselves thus hindering the ideals of the free markets. Consequently, it is also seen to obstruct the efficiency of markets by unfairly forcing small retail investors to use Bulge bracket firms to invest/trade on their behalf thereby protecting the commissions Bulge bracket firms earn on their retail businesses.
Another argument made by opponents, is that the rule may, in some circumstances, increase a trader's risk. For example, a trader may use 3 day trades, and then enter a fourth position to hold overnight. If unexpected news causes the equity to rapidly decrease in price, the trader is presented with two choices. One choice would be to continue to hold the stock overnight, and risk a large loss of capital. The other choice would be to close the position, protecting his capital, and (perhaps inappropriately) fall under the rule, as this would now be a 4th day trade within the period. Of course, if the trader is aware of this well-known rule, he should not to open the 4th position unless he or she intends to hold it overnight. However, even trades made within the three trade limit (the 4th being the one that would send the trader over the Pattern Day Trader threshold) are arguably going to involve higher risk, as the trader has an incentive to hold longer than he or she might if they were afforded the freedom to exit a position and reenter at a later time. In this sense, a strong argument can be made the rule (inadvertently)increases the trader's likelihood of incurring extra risk to make his trades "fit" within his or her allotted three day trades per 5 days.
The rule may also adversely affect position traders by preventing them from setting stops on the first day they enter positions. For example, a position trader takes 4 different positions in 4 different stocks. To protect his capital, he sets stop losses on each position. There is then unexpected news that adversely affects the entire market, and all the stocks he has taken positions in rapidly decline in price, triggering the stop losses. The rule is now triggered, as 4 day trades have occurred. Therefore, the trader must choose between not diversifying and entering no more than 3 new positions on any given day (limiting their diversification, which inherently increases their risk of losses) or choose to pass on setting stops due to fear of the above scenario, a decision which also increases the risks to higher levels than it would be present if the four trade rule were not being imposed.
FINRA - Financial Industry Regulatory Authority
Day Trading Margin Requirements: Know the Rules
We are issuing this investor guidance to provide some basic information about day trading margin requirements and to respond to a number of frequently asked questions that we have received. We also encourage you to read our Notice to Members and Federal Register notice about the rules.
Summary of the Day-Trading Margin Requirements
The rules adopt a new term "pattern day trader," which includes any margin customer that day trades (buys then sells or sells short then buys the same security on the same day) four or more times in five business days, provided the number of day trades are more than six percent of the customer's total trading activity for that same five-day period. Under the rules, a pattern day trader must maintain minimum equity of $25,000 on any day that the customer day trades. The required minimum equity must be in the account prior to any day-trading activities. If the account falls below the $25,000 requirement, the pattern day trader will not be permitted to day trade until the account is restored to the $25,000 minimum equity level.
The rules permit a pattern day trader to trade up to four times the maintenance margin excess in the account as of the close of business of the previous day. If a pattern day trader exceeds the day-trading buying power limitation, the firm will issue a day-trading margin call to the pattern day trader. The pattern day trader will then have, at most, five business days to deposit funds to meet this day-trading margin call. Until the margin call is met, the day-trading account will be restricted to day-trading buying power of only two times maintenance margin excess based on the customer's daily total trading commitment. If the day-trading margin call is not met by the fifth business day, the account will be further restricted to trading only on a cash available basis for 90 days or until the call is met.
In addition, the rules require that any funds used to meet the day-trading minimum equity requirement or to meet any day-trading margin calls remain in the pattern day trader's account for two business days following the close of business on any day when the deposit is required. The rules also prohibit the use of cross-guarantees to meet any of the day-trading margin requirements.
SEC - U.S. Securities and Exchange Commission
http://www.sec.gov/answers/patterndaytrader.htm
Pattern Day Trader
FINRA rules define a "pattern day trader" as any customer who executes four or more "day trades" within five business days, provided that the number of day trades represents more than six percent of the customer's total trades in the margin account for that same five business day period. This rule represents a minimum requirement, and some broker-dealers use a slightly broader definition in determining whether a customer qualifies as a "pattern day trader." Customers should contact their brokerage firms to determine whether their trading activities will cause them to be designated as pattern day traders.
A broker-dealer may also designate a customer as a "pattern day trader" if it "knows or has a reasonable basis to believe" that a customer will engage in pattern day trading. For example, if a customer's broker-dealer provided day trading training to such customer before opening the account, the broker-dealer could designate that customer as a "pattern day trader."
Under FINRA rules, customers who are deemed "pattern day traders" must have at least $25,000 in their accounts and can only trade in margin accounts. For more information on pattern day traders and related FINRA margin rules, please read the SEC staff's investor bulletin "Margin Rules for Day Trading."
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