Margin account rules for day traders

Day traders seek to exploit market pricing anomalies that occur during a given trading day. The trades are often made using borrowed money in the form of margin.

Day trading and pattern day trading

Day trading occurs when a security is bought and sold or vice versa on the same day in a margin account. Pattern day trading is defined as making four or more day trades over five business days, provided those trades represent over 6% of total trading activity within that five-day time frame.

If your account is flagged as a pattern day trader (PDT), you will need to follow rules that hold you to a higher standard than other investors. Violation of these rules can result in restrictions being placed on the transactions you are permitted to make. The PDT designation generally will last for the life of the margin account. The Financial Industry Regulatory Authority (FINRA) does allow a broker to remove the PDT designation from an investor upon request, but this can only be done once, absent "extraordinary circumstances."

Use of margin

Day traders use margin accounts to increase the number of shares they can purchase or to short sell securities. This can boost buying power, facilitate capturing market opportunities and may produce significant returns.

However, trades don’t always work out as expected. One major risk associated with margin is the potential greater loss of capital compared to cash purchases because you must repay your margin loan, regardless of how your securities are performing. This leads to the next risk, which is market risk. Markets fluctuate and there is no guarantee that your securities will perform well after you purchase them.

Due to the inherent risk of using leverage, regulatory agencies and brokerage firms have specific rules in place. These must be followed to retain the privilege of access to margin.

Margin account rules that you need to know

Before day trading on margin, let's consider the following account rules.

Minimum equity balance

Regulatory law requires margin accounts to maintain a minimum equity level, which is typically set at $2,000.

Accountholders below the $2,000 threshold can still use their margin accounts for trading; however, they must pay for their purchases in full – meaning there cannot be an extension of credit, while short sales and certain options trading strategies are prohibited.

However, for pattern day traders, the minimum required equity is $25,000. If the account dips below this value at the end of the business day, the account will be placed in a restricted status that lasts until the equity is brought back above the minimum. No new trading, except liquidating transactions, will be allowed until the minimum equity level is restored.

Day trade buying power

Day trade buying power (DTBP) is a key concept that refers to the margin available to the trader for use in day trades. DTBP is always based on the regulatory maintenance excess from the previous day’s close. Generally, the DTBP is four times the regulatory maintenance excess, which assumes that the securities being traded are marginable equities – day trading other asset classes may result in increased or decreased DTBP depending on their regulatory maintenance requirement. This is an indication of the amount of stock that you can day trade without triggering a day trade margin call. It is important to remember that DTBP doesn’t increase if securities were held overnight are sold – this would be reflected in the following day’s DTBP calculation.

For example, let’s say your margin account holds shares of a margin-eligible equity security worth $100,000 and no other assets. The regulatory excess is $75,000. If day trading a marginable equity security, and assuming the account is free of any restrictions, the DTBP would be $300,000 ($75,000 * 4). However, if day trading a non-marginable security (let’s say, buying a call option contract), then the DTBP is only $75,000.

Day trade calls

When DTBP is exceeded, a day trade call is issued. Day trade calls are due within five business days of the day the call was triggered (T+5). Day trade calls can be met through the deposit of cash or marginable securities with regulatory maintenance lending value equal to the call amount. Any cash deposited to meet a day trade call cannot be withdrawn for at least two business days from its deposit. Day trade calls are distinctive in the fact that, by meeting the highest open day trade call, all other open day trade calls will be simultaneously satisfied – typically all other margin calls must be met individually. However, if a day trade call is not met by its due date, then that call must be met on its own (although any and all other open day trade calls could still be met by meeting the highest open amount).

It's beneficial to understand that:

The bottom line

The key takeaway here is that day trading is risky and not suitable for most investors, so those who choose to day trade should ensure that they have enough equity in their margin account to stay above regulatory minimums, with a cushion to accommodate adverse market movements.

During times of market volatility, it can be easy to inadvertently trip up on margin and pattern day trading rules. Because of the risks associated with day trading on margin, you can shrink your account equity or end up losing more than your investment. To avoid getting hit with restrictions, it’s important to monitor your account closely and fully understand margin account trading rules.

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