A day trading account is subject to certain rules that a regular brokerage account is not. If a trader executes more than 4 or more round trip day trades in any 5 day period, the account is subject to the pattern day trader rules set forth by the SEC. The caveat is that the trades must equal more than 6% of the account’s total trading activity for the same time frame or they will not be subject to pattern day trading restrictions. A brokerage may also designate any account it wishes a pattern day trading account if it has “reasonable belief” that the account will engage in pattern day trading activities.
Any account marked as a pattern day trading account must meet certain requirements. A pattern day trading account must maintain a minimum equity balance of $25,000. If equity falls below this level a trader is only allowed to close positions for a time period of 90 days. Pattern day trading accounts must also be margin accounts (cash accounts are not subject to the pattern day trader rule because cash accounts take 3 days for funds to settle after a trade, making day trading impractical). FINRA speaks more about the minimum equity requirement in detail here.
Please not that by the definition of a round trip day trades, if a trader creates a position with multiple entries during the same day, and exits the entire position in one transaction, it is considered one round trip trade. Similarly, if a trader enters a position in one transaction and exits the position over multiple transactions during the same day, this is considered one round trip day trade.
If you open a day trading account, it will be a margin account, which means that your brokerage provider can give your account leverage to increase your buying power. This leverage is 2x your account equity for an overnight position, and 4x your account equity intra-day. This means that if your account has $50,000 of equity, during the trading session you may purchase securities totaling $200,000 in value, and at night you can hold open positions worth $100,000. Note that the $25,000 minimum equity requirement is the amount of actual equity needed, your buying power with leverage does not satisfy this requirement.
While the leverage available can be very powerful for accounts with large equity balances, for traders who do not want to commit at least $25,000 to a day trading account, the requirement can be very restricting.
There is another option for people who do not wish to invest so heavily in an account. Traders may open a proprietary trading (prop) account with a proprietary trading brokerage firm. A proprietary trading firm is a brokerage that specializes in day trading; and because of their specialty a trader’s account with a proprietary trading brokerage is not always subject to the 25,000 minimum. A trader can invest significantly less in initial funding. Instead, a trader can invest as little as about $3,000 for most firms. The firm is then able to provide the trader with their own capital, and can give a trader as much buying power as they feel appropriate. At Howwetrade, we can provide traders with an initial buying power of about $50,000 with this account funding investment. If a trader proves themselves to be profitable, the buying power will be increased accordingly. This can be a useful option for day traders who do not have the financial means to satisfy the $25,000 minimum of retail brokerage day trading accounts.
Proprietary brokerages also can offer a trader direct market access and the ability to collect rebates from transacting over ECNs.
There is a major requirement for a trader to open a day trading account with a proprietary brokerage. If a trader is based in the United States he must obtain his Series 56 license. This exam is mandated by the SEC for all United States based traders, but traders from other countries may not need to pass the exam. The exam is a 100 question multiple choice test. The Series 56 designates the holder as a professional day trader, and as a professional they are assumed to understand the risks and rewards of the stock market, and are deemed capable of making logical decisions regarding their trading.
If you are interested in learning more about how to be a day trader and the requirements to do so please feel free to ask us for additional information.