Today’s day trader, by definition, engages in pattern day trading, as defined by the U.S. Security and Exchange Commission (SEC), which has implemented these new definitions and rules governing the practice.
A pattern day trader is one who executes four or more day trades (the entering and exiting of a transaction in a single security in a given day) over five business days.
Also, to meet this criteria, the number of day trades exceeds six percent of the trader’s total trading activity, measured in gross dollars, over a five day period. The rationale is that such a trader is exposed to greater risks, and thus, is subject to more stringent disclosure requirements and capital reserve thresholds.
As casual trader who exceeds these minimum criteria is immediately subject to these regulations. However, if the brokerage knows or believes the intention of the trader is to engage in day trading at this pace or more, then the five day period is waived and the margin criteria (see below) that applies to day traders becomes effective immediately.
Defining Patterns further
Pattern day traders are subject to a minimum of $25,000 equity balance in a margin trading account. This minimum balance must be maintained even as trading proceeds, meaning that if your balance drops below this threshold due to trading, your activity must cease until new funds are added to bring the account up to the $25, 000 minimum balance, beginning the next business day.
Brokers are not required to monitor or enforce this on an intra-day basis, only beginning the next trading day. Meaning that a trader who falls below the threshold must make up ground in an effort to end the day in excess of it by the end of the trading day.
Margin calls must be satisfied within five business days or trading privileges are suspended. If a trader qualifies as a pattern day trader then stops trading, three months must pass before pattern trading can begin again. In essence, they are limited to less than four day trades, or the sum of their day trades cannot exceed six percent of their total trading activity for a period of three months.
The SEC, which passed these regulations in February of 2001 (known as Rule 252), argues that this protects smaller, less sophisticated traders from, in essence, their own lack of experience and trading ability. Just as a hedge fund trader must demonstrate a net worth excess of $1 million, a day trader needs to, in the view of the SEC, be able to weather the potential rapid decline in assets resulting from bad trades, thus protecting the broker from margin calls that the trader is not able to meet.
This filtering of low-end day traders is the hallmark of today’s day trading niche, which is occupied by savvy investors with the skill and net worth to navigate these tricky waters.
