Day Trading Margin Rules

Day trading margin requirements have come under increased scrutiny with the advent of electronic trading which increased the popularity of trading. The increased number of day traders increased the volatility of stock prices and the risk to the financial sector. In answer to this risk the National Association of Securities Dealers (NASD) and the New York Stock Exchange (NYSE) require a minimum trading requirement of $25,000 for all day traders. The penalty for breaking this requirement is reduction in margin. This article will define day trader, margin, the requirements of the rule and the penalty associated with breaking the rule.

History

A single rule regarding the minimum equity requirement for day traders was published by the Securities and Exchange Commission on February 18, 2000. The rule set out to reduce the risk and overall volatility of the equity markets caused by day traders by increasing the minimum equity requirement for pattern day traders. Both the NASD and the NYSE published similar rule changes. After over 250 comment letters, the SEC approved the rules set forth by both trading houses on February 27, 2001. NASD's rule 2520 states that their new, "...minimum equity requirement for a 'pattern day trader' is $25,000...". It goes on to define day trading and pattern day trader in great detail, but ultimately a brokerage has full discretion to designate any of its clients as pattern day traders without client consent.

Definitions

Half of understanding day-trading margin-rules is defining the terminology. In this case, a "day trade" refers to a stock purchase or sale of the same stock on the same day. A "pattern day trader" must satisfy two rules. They must make more than 4 trades in the same 5 business days and they must meet a trading activity threshold of 6 percent.

Requirements

Your brokerage has the discretion to designate you as a pattern day trader if it can prove two pattern day trading requirements within reason. If you receive "pattern day trader" status by your brokerage the minimum requirement to have in the account, as a combination of cash and equities, is $25,000. This is considerably higher than the minimum equity amount of $2,000 established before the advent of electronic trading. The penalty for breaking the $25,000 threshold affects your buying power.

Buying Power

Buying power, or the amount you are allowed to leverage your account, is 4 to 1. That is, your buying power is four times the amount you have deposited in your account. Some firms may have tighter policies. Check with your brokerage to be sure.

Penalty

The penalty for going over your buying power (margin call) is a reduction in buying power to 2 to 1 leverage until you can pay up on your margin or 5 business days, whichever is less. If on the 5th day the account continues to be outstanding you will be restricted to a "no-margin" account, which simply means you have no leverage for 90 days or until the margin call is satisfied.

Resources

• NYSE: Information Memo on Day Trading Requirements