A Guide to Margin Day Trading
Traders can use margin to increase their purchasing power and leverage into larger positions than they could with cash alone. In addition, traders can multiply gains and possible losses by borrowing money from their broker to trade in larger sizes.
Day trading entails purchasing and selling the same stocks many times during trading hours in the hopes of profiting quickly from price fluctuations. However, day trading is dangerous since it is based on daily changes in stock prices and can result in significant losses in a short period.
Day Trading and Margin
Buying on margin is a method that allows traders to trade even if they don’t have the necessary funds on hand. In addition, buying on margin increases a trader’s purchasing power by allowing them to buy at a higher price than in cash; a brokerage firm covers the difference at interest.
The hazards are amplified when these two tools are combined in the form of day trading on margin. And according to the adage, “the larger the risk, the greater the possible return,” the rewards can be multiplied many times over. However, be aware that there are no promises.
A day trade is defined by the Financial Industry Regulatory Authority (FINRA) as “the acquiring and selling, or the selling and purchasing, of the same security in a margin account on the same day.” A day trade also includes short-selling and purchases to cover the same security on the same day and options.
When it comes to day trading, some people do it regularly and have different margin requirements than those considered “pattern day traders.” So let’s have a better understanding of this terminology and FINRA’s margin rules and criteria.
A pattern day trader is someone who makes four or more day transactions in five business days if one of two conditions is met:
During the same five-day period, the number of day trades is more than 6% of his total trades in the margin account.
Within 90 days, the person makes two unfulfilled day trade calls. As a result, day trading only occurs on rare occasions on a non-pattern day trader’s account.
If any of the above requirements are met, a non-pattern day trader account will be labeled as a pattern day trader account. If a pattern day trader account does not make any day trades for 60 days in a row, it is reclassified as a non-pattern day trader account.
Requirements for Margin
To meet the first margin requirement, investors must deposit sufficient cash or suitable assets with a brokerage firm to trade on margin. According to the Federal Reserve’s Regulation T, investors can borrow up to 50% of the total purchase cost on margin, with the remaining 50% deposit by the trader as the first margin requirement.
What is the definition of a margin deposit?
A margin deposit meaning The initial amount of money a trader must put down in order to initiate a leveraged trading position is known as a margin deposit. The deposit is often referred to as the beginning margin, deposit margin, or simply the deposit.
CFDs, for example, are leveraged instruments that allow traders to open a position with a fraction of the capital required. Unfortunately, although this can increase your profits, it also has the potential to increase your losses.
The margin deposit is commonly expressed as a percentage of the trade’s full value, as determined by the leveraged provider’s margin system. The amount of deposit margin required varies depending on the derivative and market being traded. For example, more deposit margins may be required in markets with higher volatility or larger stakes.
A margin deposit is one of the two types of margin required to maintain an open leveraged position.
A pattern day trader’s maintenance margin requirements are substantially higher than a non-pattern day trader’s. For example, a pattern day trader’s minimum equity need is $25,000 (or 25% of the total market value of assets, whichever is larger). In contrast, a non-pattern day trader’s minimum equity requirement is $2,000. This condition must be met independently by each account classified as a day trading account, not by cross-guaranteeing several accounts. If the account falls below the $25,000 limit, no more trading is authorized until the account is replenished.
Calls on the Margin
If your account falls below the maintenance margin amount, you will receive a margin call. A margin call is a request from your brokerage for you to deposit funds or cancel down holdings to restore your account to the required level.
If you fail to meet the margin requirement, your brokerage firm may cancel any open positions to restore the account to its minimal value. In addition, your brokerage firm has the authority to liquidate positions without your permission and can pick which ones to liquidate.
Your brokerage firm may also charge you a commission for the transaction (s). Your brokerage business may liquidate enough shares or contracts to exceed the initial margin requirement, and you are responsible for any losses incurred during this process.
Purchasing Power on the Margin
A pattern day trader’s buying power is four times the excess of the maintenance margin as of the previous day’s close of business (for example, if an account has $35,000 after the previous day’s transaction, the surplus is $10,000 because of this amount above the minimum requirement of $25,000. This would offer you $40,000 in purchasing power (4 x $10,000). If this is surpassed, the brokerage business will send the trader a day trading margin call.
To meet the margin call, you have five business days to do so. Buying power in day trading is limited to two times the maintenance margin excess. If the margin is not satisfied within the specified time frame, further trading is only permitted on a cash available basis for the next 90 days or until the call is met.
Trading on Margin: An Example
A trader has $20,000 greater than the required maintenance margin. This gives the trader $80,000 in day trading purchasing power (4 x $20,000). If a trader purchases $80,000 of QPR Corp at 9:45 a.m. and $60,000 of XYZ Corp at 10.05 a.m. on the same day, he has surpassed his buying power limit. Even if he sells both during the afternoon trade the next day, he will receive a day trading margin call. However, by selling PQR Corp before buying XYZ Corp, the trader may have avoided the margin call.
Day trading on margin is a high-risk activity that beginners should not attempt. People who have done day trading before should exercise caution. Using margin increases a trader’s purchasing power; however, it should be utilized carefully for day trading to avoid large losses. Limiting yourself to the margin account’s defined limitations can help you reduce margin calls and, as a result, the need for more funds. Don’t start with a margin account if you’re new to day trading.
This article has been published in accordance with Socialnomics’ disclosure policy.