Understanding Day Trading
D ay trading can be challenging to master because it means only holding securities for a day. In addition, investors don’t want to be issued a day trade call, which means they’ve violated their margin account. They also don’t want to have their account labeled as a pattern day trader and have restrictions placed on their account. It’s essential to understand what day trading entails to avoid making any adverse actions.
- A pattern day trader is someone who engages in four or more day trades within five business days.
- Pattern day traders are required to have a margin account with a minimum equity requirement of $25,000.
- Day trade buying power is how much an account can day trade without producing a day trade call.
- A day trade call is issued when a trader violates their margin account.
What Is Day Trading?
Image via Flickr by cafecredit
A day trade is an opening trade followed by a closing trade on the same security on the same day. If four or more day trades are made within five consecutive business days, the account owner will be considered a pattern day trader. The account will then be held to different requirements and rules, such as a $25,000 minimum equity requirement. When an investor buys and sells on the same business day in a margin account, their account will be labeled as a pattern day trader, and they’ll have to follow pattern day trader rules.
Day Trade Call
Investors who are issued a day trade call, occasionally referred to as daily trading call, have violated their margin account. An investor has five days to meet the call by adding cash or marginable securities into their account. After depositing the funds to meet the day trade call, the funds are placed on a two-day hold to consider if the day trade call has been met. Days are added to the hold if it takes longer for the funds to move.
Investors can’t use cross-guarantees to meet the day trade call, and some securities are not eligible either. Investors have to meet the call with cash or approved marginable securities.
Becoming a Pattern Day Trader
A pattern day trader participates in four or more day trades within five business days. The number of day trades also has to be more than 6% of their total trading activity in those five business days. Pattern day traders must meet the minimum equity requirement.
Understanding the Minimum Equity Requirement
The Financial Industry Regulatory Authority (FINRA) requires that accounts belonging to pattern day traders must maintain a day trader minimum equity requirement of $25,000. Having cash and marginable securities held within the account will allow the investor to meet this requirement. If investors fall below the $25,000 margin, a day trade minimum equity call is issued.
If an account falls below the $25,000, the investor won’t be allowed to day trade until they meet the minimum equity requirement. Investors get five business days to meet the criteria. The account is limited until it reaches two times the maintenance margin excess of daily total trading power. If the call is still not satisfied after the five days, the account will be further restricted. In this case, investors will be allowed to trade with cash only for 90 business days or until they finally meet the day trade call minimum equity requirement.
Some brokerage firms have their own rules beyond the minimum equity requirements, so pay attention to the firm’s rules. A firm also may label an account as a pattern day trader if they believe that the account will engage in pattern day trading.
An account can have the pattern day trader label withdrawn if there aren’t any day trades with the account for 60 days.
Day Trade Buying Power
Day trade buying power is the amount an investor can trade from their account in a single day without generating a day trade call. Day trade buying power is fixed and decided by the balances from the account on the previous day. Investors can’t increase their account balance by selling already-held securities. In addition, the funds required for day trading must be held in the margin account one business day before figuring out the day trade buying power. If the total profit of all day trades, in one day, surpasses the starting day trade buying power, a day trade call is issued.
How Do You Day Trade?
Follow these steps to prepare for day trading:
- Do your homework. Research the stocks you would like to trade and keep an eye on the market.
- Keep extra funds handy. You may need to trade with these additional funds or be willing to lose them. Make sure you know how much money you’re ready to risk each trade.
- Make sure you have the time to invest yourself fully into the trades. You’ll most likely have to give up your whole day. That’s the reason it’s called day trading. You’ll have to be ready to move fast on good opportunities throughout the day.
- Start small. Keep an eye on one or two stocks you’re interested in and watch them for opportunities.
- Learn market times. The mornings can be quite volatile with all the trades beginning at once. The end of the day can be quite chaotic, especially as people try to get last-minute trades done. The middle of the day tends to be the calmest, so for beginners, this may be the best time to trade.
- Make sure you keep calm. When you’re a day trader, a lot happens in a small amount of time. Keeping emotions at bay while trying to be logical is the best course of action. Have a plan of action and stick to it.
- Maintain good relations with your brokerage firm. Know and understand your brokerage firm’s equity level requirements. All firms will have the initial requirements, but some will also have conditions that are unique to their firm. Some require investors to hold more than the minimum equity requirements set in place by FINRA.
Real-World Examples of Daily Trading Calls
To better understand the process of day trading and possible outcomes, look at a few of these examples.
Example One: Day Trade Call
You buy and hold a security in MNO stock overnight, using most of your intraday buying power. You sell your shares of MNO the next business day, which gains you more margin buying power. You use the profit from the sale of MNO to buy shares of QRS stock.
Your firm allows the trade based on the assumption that you will hold your shares of the QRS stock overnight. However, the QRS stock drops during the day, and you sell your shares. Since you used margin buying power and not day trading power, your brokerage firm will issue a day trade call.
Example two: Day Trade Margin Call on Your Account
You begin the day with $1,000 in margin equity, and your day trade buying power is also $1,000.
- You make your first trade at 11 a.m.
- You buy 50 ABC at $55 for a total cost of $2,750.
- You make your second trade at noon.
- You sell all your ABC (50) stock at $56 and increase your buying power to $3,050.
- Your third trade you make at 12:30 p.m.
- You buy 100 shares of CCC at $29 for a total cost of $2,900.
- Your last trade of the day takes place at 2 p.m. You sell your shares of CCC at the same price you bought them at $29.
- While neither buys exceeded your day trade buying power, you still have to add all the day-trade requirements. When you add $2,750 to $2,900, you get $5,650. Now you have to subtract your day trade buying power from your total. $5,650 – $1,500 equals $4,150. The $4,150 surpasses your starting day trade buying power and will have your brokerage firm issuing a day trade margin call to your account.
D ay trading calls can be an exciting way to invest in the stock market, but day traders need to be well-versed in the stock market and the nuances specific to day trading. Investors who are just starting may want to learn more about day trading until they’ve gained more experience. If you decide to day trade, make a plan and stick to it.