Day trading can be luring if you want to make some quick money. However, there are several day trading rules that you must keep in mind while trading stocks or any other form of securities.
You may have to pay a lot if you fail to adhere to these rules, so make sure you follow them closely. Some of these rules can vary depending on where you trade from and the volume you trade. However, some rules are constant and must be followed irrespective of your location or trading patterns.
You can trade stocks and securities only through regulated brokers and market exchanges. The Securities and Exchange Commission (SEC) oversees all the stock trading regulations in the United States. The brokers are regulated by The Financial Industry Regulatory Authority (FINRA), which is a self-regulatory body approved by the government.
If you are new to the world of trading, you should read a beginners guide to day trading that covers several crucial topics. We will discuss five rules that you should never break when you day trade in this post.
Pattern Day Trader Rule (PDT)
According to this rule, you must not execute more than three round-trip intraday trades in five days if you do not have at least $ 25,000 in your brokerage account. If you have less than $ 25,000 in your margin account and still make more than three trades in five business days, you will get flagged to violate the PDT rule.
You can rectify a PDT rule violation by depositing more money into your brokerage account and raising it above the $ 25,000 threshold. However, repeated PDT rule violations can have detrimental effects, such as account suspension or even termination.
It is best if you maintain your trading account balance of more than $ 25,000 so you do not get stuck in overnight positions. However, if you do not have adequate funds, keep the PDT rule in your mind and trade wisely.
It can take up to 2 days for trades to settle before you can use the funds again to buy stocks. If you have a margin account, you can use the money to buy a position immediately after selling one because these accounts can be exempt from the two-day rule.
However, if you have a cash account, you will have to follow the two-day settlement rule and refrain from using the funds for two days after selling a position. Brokers usually monitor these factors and disable the feature in cash accounts to trade with unsettled funds.
But some brokers may forget to do that with your cash account. If you trade with unsettled funds on a cash account, you can trigger a Regulation T violation, also known as a free ride trade violation. It can restrict you from using your trading account for day trades in the future.
Regulation SHO/Uptick Rule
The SEC has established some rules for shorting a stock with SHO regulations. These regulations list out the standards and practices that brokers or traders must follow for short sales. That is why the SEC has established the Uptick Rule, also called the “plus tick rule,” to ensure that short sales are conducted with a higher value than the last trade.
Investors short sell if they feel that the price of a stock or security is about to fall, so they can sell high and buy low once the price has fallen. Even though short selling can optimize market liquidity and efficient pricing, people misuse it to drive the stock price too low, resulting in a market decline.
Therefore make sure that you do not short sell a stock that has fallen below the 10% price threshold on the trading day. If you want to be a short seller, you should know how to execute short trades by staying within the regulation.
Wash Sales is referred to as selling a security at a capital loss and then buying the same or similar security within 30 days. If that happens, the tax claim for the capital loss will be denied and added to the cost of newly purchased stocks.
The Wash Sale rule has been implemented to prevent traders from taking undue advantage of the tax system. You should also know that according to the Wash Sale rule, your spouse or your company cannot repurchase the stocks you sold at a capital loss within 30 days.
The Margin Call Rule
If you are trading with a margin account, your brokerage firm will ask you for a cash deposit. You can use your cash deposit and the loan you get from the brokerage firm to purchase stocks and securities. If the value of the stocks or securities you purchased increases, you can sell them and keep the profit after paying back the loan with interest.
But in case the securities you bought take a downturn, your brokerage firm can ask you to pay back the loan immediately. It is known as a margin call. You can either use your cash at hand or sell other investments to pay back the money you owe to the firm.
Failure to pay can affect your credit rating as the brokerage firm will file a negative credit report against you. You may also face difficulties opening a margin account in the future, or the brokerage firm can take legal action against you. You can avoid margin calls by trading with cash-only accounts, even though it may limit your earning potential.
The stock trading market can lure you with profits from the comfort of your house through your laptop or smartphone. It can be a rewarding experience as long as you abide by the rules and regulations. Apart from government regulations, also learn the rules of risk management before you trade with stocks or securities.