Margin Rules for Day Traders

In our effort to provide relevant educational information to the investing public, we have created a section on our website styled “frequently used investment terms and concepts.” We have just finished an arbitration case where this type of trading was the main focal point, as was the use of margin, neither of which was fully understood by the parties. Hopefully, it was by the arbitrators.

Please keep in mind that the information being provided herein is for educational purposes only and should not be relied upon as legal or investment advice. If you do have any questions, you should contact and experienced professional.

As fate would have it, the SEC’s Office of Investor Education and Advocacy recently issued this Investor Bulletin to help educate investors regarding the margin rules that apply to day trading in a Regulation T margin account and to respond to a number of frequently asked questions that the SEC has received.

Executing four or more day trades within five business days = “pattern day trader”

If a broker-dealer designates a customer as a “pattern day trader” Financial Industry Regulatory Authority (FINRA) margin rules require that broker-dealer to impose special margin requirements on the customer’s day trading accounts.

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. Customers should note that this rule is a minimum requirement, and that some broker-dealers use a slightly broader definition in determining whether a customer qualifies as a “pattern day trader.” The SEC recommends that customers contact their brokerage firms to determine whether a broader definition applies to their trading activities. 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.

FINRA rules define a day trade as: The purchasing and selling or the selling and purchasing of the same security on the same day in a margin account. This definition encompasses any security, including options. Also, the selling short and purchasing to cover of the same security on the same day is considered a day trade.

Exceptions to this definition include: a long security position held overnight and sold the next day prior to any new purchase of the same security; or a short security position held overnight and purchased the next day prior to any new sale of the same security.

Minimum Equity Requirement: The minimum equity requirement for a customer who is a pattern day trader is $25,000. This $25,000 requirement must be deposited into the designated customer’s account prior to any day trading activities and must be maintained at all times. A customer cannot fulfill this $25,000 requirement by cross-guaranteeing separate accounts. Each day trading account is required to meet the $25,000 requirement independently, using only the financial resources available in that account. If a customer’s account falls below the $25,000 requirement, the customer will not be permitted to day trade until the customer deposits cash or securities into the account to restore the account to the $25,000 minimum equity level.

A customer who is designated as a pattern day trader may trade up to four times the customer’s maintenance margin excess as of the close of business of the previous day for equity securities. If a customer exceeds this day trading buying power limitation, the customer’s broker-dealer will issue a day trading margin call. The customer has five business days to meet his or her margin call, during which the customer’s day trading buying power is restricted to two times the customer’s maintenance margin excess based on the customer’s daily total trading commitment for equity securities. If the customer does not meet the margin call by the fifth business day, the day trading account will be restricted to trading only on a cash available basis for 90 days or until the call is met.

Important Note: A broker-dealer may impose a higher minimum equity requirement and/or restrict day trading buying power to less than four times the day trader’s maintenance margin excess. Customers should contact their brokerage firms to obtain more information on whether it imposes more stringent margin requirements.

Please note that additional rules apply to customers who day trade in a portfolio margin account. For additional information regarding the rules for day trading in a portfolio margin account, please see the following FINRA bulletin: FINRA Portfolio Margin Frequently Asked Questions – Day Trading