Abiding by the SEC day trading rules is essential if you are planning on getting involved in day trading as an investment style. The SEC has specific rules when dealing with individuals that are considered to be pattern day traders. Here are the basics of what the SEC expects out of day traders and how to make it work.
Pattern Day Traders
The SEC rules apply to you only if you are considered to be a pattern day trader. Just because you buy and sell a security in the same day, that does not necessarily mean that you are a pattern day trader. You have to show that you engage in this activity frequently. According to the SEC, you have to buy and sell the same security in the same day at least four times. If you do this four out of five days, then you are considered a pattern day trader. This activity of trading the same securities has to be more than 6 percent of your trading in order to qualify as well. Therefore, you could potentially do a little bit of trading the same security in one day without necessarily qualifying as a pattern day trader.
If you are considered to be a pattern day trader, you will have to open a margin account with your broker. A margin account is a type of trading account that utilizes borrowed funds from your broker in order to increase the amount of money that you have available to you. This can increase the potential returns that you generate, but it can also increase the losses. In order to open a margin account, you will have to meet certain elements of creditworthiness as determined by your broker. They will most likely put a limit on how much money you can borrow and give you the terms of borrowing the money.
In addition to opening a margin account, you will also have to have a balance in your account of at least $25,000. This is a significant amount of money for most traders and eliminates many potential individuals from this type of trading. This restriction is to ensure that only those who can afford some losses get involved. The market moves very quickly over the course of a day, and if you are investing with a short-term time horizon, you could potentially suffer some big losses quickly.
Risk and Reward
This type of trading can be very rewarding if you have a strategy that works. If you do not learn the basics before getting involved, you could potentially lose a large portion of the $25,000 that you have to invest. Because of this, you need to sign up for a practice trading service before actually getting involved. This can help you learn the basics of day trading without actually putting any of your money on the line until you are ready.