Trading stocks can be fun and profitable, but violation of a Securities and Exchange Commission rule covering brokerage accounts may result in a restriction on your account or even a call to send more cash to your broker. The secret to staying out of trouble with the SEC is to use the right type of brokerage account for your style of trading.
Cash Account Restrictions
A cash brokerage account lets you buy stocks up to the amount of available cash in your account. Restrictions come into play if you try to trade stocks with money that is not officially yours. A stock trade takes three days to become official or "settle." So if you sell shares, the cash will show immediately in your account but will not be officially yours for three days. You may buy stock with unsettled cash, but if you then sell the same stock before the settlement of the initial sale, you have engaged in free riding, which is prohibited. Rapid trading of stocks with a low cash balance will not work in a cash account. You also cannot short-sell stocks with this type of account.
Margin Account Restrictions
A margin brokerage account allows you to borrow up to half of the cost of stock shares when you invest or trade. With a margin account you can also sell stock short and do not need to worry about trading with unsettled cash. SEC margin account rules require you to maintain a minimum of $2,000 of equity -- which is the value of the account minus any margin loan. Brokerage equity is your skin in the game. Equity must stay above 25 percent of the account value or the broker will ask for more cash and has the authority to sell any of your stocks if you do not meet the margin call. You cannot regularly day trade -- buying and selling a stock during the same day -- in a standard margin account.
Day Trading Limits
If you day trade too often in a standard margin account, SEC rules require that you be classified as a "pattern day trader." Your margin account must then follow the day trading margin rules in addition to the regular margin account rules. You will be hit with the pattern day trader tag if you make more than four day trades in any five business day period and those trades form more than 6 percent of your trading activity.
Pattern Day Trading Account Restrictions
If your brokerage account gets labeled as a day trading account, you must maintain at least $25,000 in equity. This is the SEC minimum, and your broker may require a higher amount of equity. The day trading rules allow you to have open trades worth up to four times your equity during the stock market day. Brokers call this four-times buying power. Exceed the buying power limit and the broker will require you to deposit more cash. If you don't make the deposit, your buying power will be restricted to one times equity. You cannot withdraw equity used to support trading up to the buying power limit. If you want to take money from your day trading account, you must trade at a lower activity level for two days.
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