What Are Day Trading Rules for Margin and Cash Accounts?

Day trading involves buying and selling the same security within a single trading day, aiming to profit from short-term price movements. This rapid succession of transactions presents unique risks to investors and the broader market. Regulatory frameworks and rules are in place to govern this activity, primarily established by the Financial Industry Regulatory Authority (FINRA) to manage risk exposure. These regulations are designed to ensure market stability and investor protection, particularly when trading with borrowed funds or engaging in frequent transactions.

Defining Day Trading and Pattern Day Trader Identification

A “day trade” is defined as the purchase and sale of the same security within the same trading day. This definition applies across various security types, including stocks and options, and encompasses both long and short positions. The concept of a “round trip” trade is central to this definition.

An individual becomes identified as a “Pattern Day Trader” (PDT) under FINRA rules if they execute four or more day trades within any five consecutive business days. This classification is primarily applied to margin accounts. These day trades must represent more than 6% of the total trades executed in the margin account during that same five-business-day period.

Brokerage firms are responsible for tracking and identifying accounts that meet the Pattern Day Trader criteria. They employ systems to monitor trading activity and determine if a client’s trading patterns trigger this designation. Firms have the discretion to designate an account as a Pattern Day Trader if they believe the customer will engage in frequent trading, even before the four-trade threshold is met.

Financial Requirements and Restrictions for Pattern Day Traders

Once an account is identified as a Pattern Day Trader, financial requirements and trading restrictions are imposed. A primary requirement is maintaining a minimum equity of $25,000 in the margin account. This equity, which can consist of cash and eligible securities, must be present in the account before any day-trading activity commences.

Should the account’s equity fall below the $25,000 minimum, the Pattern Day Trader will be restricted from further day trading until the account is restored to the required level. The firm will not permit day trading until the minimum equity is met.

Pattern Day Traders are also subject to limitations on their “day-trading buying power,” calculated as up to four times the maintenance margin excess. Maintenance margin excess refers to the amount by which the equity in the margin account exceeds the brokerage firm’s required maintenance margin. For instance, if an account has $10,000 in excess of the maintenance margin, the day trading buying power would be $40,000.

Exceeding this day-trading buying power can result in a day-trading margin call issued by the brokerage firm. The trader is granted up to five business days to deposit additional funds to meet this call. During this period, the account’s day-trading buying power may be restricted to two times the maintenance margin excess. If the day-trading margin call is not met within the specified timeframe, the account will face further restrictions, limited to trading only on a cash-available basis for 90 days.

Day Trading Rules in Cash Accounts

Day trading in cash accounts operates under a distinct set of regulations compared to margin accounts, as the Pattern Day Trader rule does not apply. Instead, trading in cash accounts is governed by rules related to the settlement of funds and securities. For most stock transactions, the standard settlement period is T+1 (trade date plus one business day). This means that funds from a sale become available and securities from a purchase are officially transferred one business day after the trade is executed.

A significant rule in cash accounts is the “Good Faith Violation” (GFV). A GFV occurs when an investor purchases a security with unsettled funds and then sells that security before the initial purchase funds have officially settled. For example, if an investor sells shares on Monday, the proceeds will settle on Tuesday; using those unsettled Monday proceeds to buy new shares on Monday and then selling those new shares before Tuesday’s settlement would trigger a GFV.

Accumulating multiple Good Faith Violations can lead to account restrictions. If an account incurs three Good Faith Violations within a 12-month rolling period, the brokerage firm will restrict the account to “settled cash status” for 90 days. During this restriction, the investor can only place new trades if they have sufficient settled cash in the account prior to placing the order.

Another rule in cash accounts is the “Free Riding” violation, a breach of Regulation T. Free riding occurs when an investor buys a security and sells it without ever having paid for the initial purchase with settled funds. This means the investor is essentially using the proceeds from the sale to cover the cost of the original purchase, rather than using their own capital.

A single Free Riding violation results in the account being frozen for 90 days. During this 90-day period, the investor is restricted to purchasing securities only with funds that are already settled and available in the account. The purpose of these rules is to prevent investors from trading without sufficient capital and to ensure timely payment for securities transactions.