Recently, my publisher received an inquiry from a reader about day trading stocks. He said that his broker told him it was illegal to hold stocks for less than three days. What’s going on?
Here’s the deal, and it’s complicated:
Federal securities laws, and FINRA, call for a three-day settlement period for stock trades in cash accounts. If you trade a stock today, the money will actually clear hands three days later, so the funds will be held in your account until then. You can certainly day trade, but only as long as your account has the funds for your trades to clear. This is known as Regulation T, and your broker can’t make an exception for you no matter how nicely you ask.
If you qualify as a pattern day trader, you can borrow more money, which makes it easier to comply with the 3-day settlement requirement. This is margin account with at least $25,000 in equity, and determination is based on trading activity.
Someone who is interested in day trading but who does not yet qualify as a pattern day trader has a few options. The first is to sign a margin agreement which will allow you to borrow money and give you a little more trading flexibility. (Margin also increases risk, but you really can’t day trade without it.) Also, the more funds you have in your account, the more trades you can make without running into settlement problems.
Another alternative is to trade something other than stocks. Mini-sized futures and currency are popular with day traders because they can be traded with smaller amounts of money, although these assets have their own risks. Know what you’re trading!
These restrictions are designed to protect the overall financial system by helping to ensure that if you buy or sell something, the person on the other side will deliver the security or the case. They also help to protect people who do not know what they are doing when they try to day trade.
Day trading is risky stuff, and it’s not for everyone. The more you know about these little nuances of the business, the smarter you can be when you execute your strategy.
After you first enter the world of day trading stocks or if you are starting a new day trading strategy, it would be wise to spend some time online “paper trading” before you spend real money. This simulation will give you a rough idea of whether or not your strategy, if executed properly, has a good chance of becoming profitable. What many beginning day traders forget, however, is that there is an entire world of difference between paper trading and live trading.