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DECEMBER 4, 2020

What are the rules for day trading?

Answered by
Jessica Inskip
Vice President Consumer Investments Advanced Product Experiences at Merrill
A day trade occurs when you open and close a position within a single trading day. These types of trades can include:
  • Buying a security outright (what's called "long") as an opening transaction and then selling as closing transaction.
  • Borrowing shares of a security, then selling them as an opening transaction with the hope of buying them back later that day at a lower price to cover the position as a closing transaction. (This is also called a "short sale" or "shorting.")
  • Shorting a security as an opening transaction and buying the same position long as an opening transaction.
  • Buying a security long as an opening transaction and selling the same security short as an opening transaction.
Are all day trades subject to special requirements? Yes, all day trades are subject to day trade requirements. However, if you make four day trades in a five-day period, you're classified as a pattern day trader and subject to specific margin requirements.
What are the margin rules for pattern day traders? The Financial Industry Regulatory Authority (FINRA) requires brokerage firms to monitor pattern day trading accounts, which are subject to the following special margin rules:
  • Minimum equity requirement: As a pattern day trader, you are required to hold a minimum of $25,000 in your account at all times. This can be a mix of cash and securities. If your account falls under this minimum, your account will be restricted until you've deposited enough cash or securities to meet the minimum equity requirement.
  • Day trading buying power: The rules for pattern day traders also affect the dollar amount you can buy and sell in a single day. Your day trade buying power is always determined on close of business values. Which means you will likely have a new buying-power amount every morning. Your day trade buying power is calculated by adding the firm maintenance excess (FME), which are funds above the minimum required for the securities in your account, to available cash. That sum is then divided by your broker's margin requirement for the security you are day trading, which at Merrill is normally 30% for fully marginable securities (those trading over $10.00 a share or listed on a major exchange).

    Here's an example: if you start the day with cash plus firm maintenance excess of $3,000, your day trading buying power would be $10,000 ($3,000/0.30 = $10,000). In this example, you can buy 100 XYZ shares for $6,000, and 100 ABC shares for $4,000. When these opening transactions are closed, you are credited back the opening price, and your gain or loss will affect the following trading day's day trade buying power and the current day's buy and hold buying power (a security you wish to hold overnight). So if you sell all your XYZ shares, you will have the full purchase price ($6,000) credited back to your day trade buying power, regardless of how much you gained or lost on the XYZ trade. This is sometimes referred to as "recycle" or "time and tick."

    If you exceed your day trading buying power with an opening transaction, any trade above the limit will need to be held overnight. If you close the position, you will also receive a day trade call and your account could be put on restrictions.
  • Day trade call: If you surpass the limit on your day trading buying power and close the position in the same day, your broker will issue a day trade call, requiring you to provide more funds to return the account to compliance. For pattern day trading designated accounts, you have four days to satisfy the call. During those four days, you may trade only twice your firm maintenance excess. If you don't meet the call, you'll be placed on a 90-day restriction period, during which you can only trade on a "cash available basis," which is the equivalent to your current firm maintenance excess, until you fund the call. Time and tick will also be unavailable. For non-pattern day trader accounts, if the day trade call is not satisfied within the four business days, the account will be restricted for 90 days. Further restrictions can also occur for frequent unmet day trade calls.
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