Tip #1: 10 things new traders only learn from experience

New to trading? Small account? You MUST read my novice trader tip series!

As I have mentioned in previous posts I am still a relatively new stock trader and I only started trading 18 months ago by following this guy’s strategy and alerts click here . Please see my review of his  excellent strategy here.

My learning curve has been steep over this last year, I have been very profitable and I would like to give back as best I can. My plan is to share ten top tips that will help new traders make more money, more easily and not have to learn them the hard way!

I am going to post an important tip regularly over the next several weeks which will hopefully help beginning traders become more profitable faster!

Tip #1: Pattern Day Trader (PDT) and common margin call pitfalls.

Pattern Day Trader (PDT) rule: This one took me a couple of margin calls to finally understand and get straight!  The basic idea is that the SEC considers any trader who executes 4 or more day trades in a margin account within 4 business days to be a pattern day trader.  But what constitutes as one day trade? And why would we care? If your equity balance in a margin account falls below $25,000 and you are a classified as a pattern day trader you will receive a margin call! This rather irritating process involves your account being frozen until you deposit the required funds to bring the account back up over the minimum equity! This can result in you missing valuable opportunities in the market and even lead to having your account frozen for 3 months.

How to avoid being classified as a pattern day trader

If there is one thing to take away from this post it is this: Day trades are counted on the SELL side. This might sound simple but it has significant implications. For example if you buy stock XYZ and then sell your whole position in quarters over the same day you will be immediately be classified as a pattern day trader!  This means you cannot let your account balance fall below $25,000 or risk a margin call. However, you are allowed to buy a stock as many times as you like in a single day and your account will not be classed as a PDT account as long as you do not sell that stock more than 4 times that day (assuming you have not made any other day trades during the last 4 business days).

Two different ways to meet a margin call

So what happens if you are classified by your clearing firm as a pattern day trading account and the account equity falls below $25,000?  You receive a margin call (your account buying power goes to zero!) for the amount required to bring the equity over $25,000 which you can meet in two different ways. First, you can simply deposit the required cash into the account and you are done. However, the second way is that you can sell some stock to bring your account over the $25,000.

HOWEVER, please note that my broker did not inform me that you can only meet a margin call in this way three times! Each time you meet a margin call by selling stock you get a ‘strike’ against the account. If on the fourth margin call you sell stock to meet the call your account will be frozen for 3 months. Nothing you can do at that point will unfreeze your account.

I hope this information helps some people with accounts around the $25,000 region survive and utilize margin safely.

Good luck trading!

Russell

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15 thoughts on “Tip #1: 10 things new traders only learn from experience

  1. Malick Bourabah

    You said: <>
    How is that possible if the equity is less than 25,000? selling more stocks won’t change the equity… any thoughts?

    Reply
    1. Malick Bourabah

      Here’s the portion I commented out above: However, the second way is that you can sell some stock to bring your account over the $25,000.

      Reply
    2. barbour2phyrb Post author

      Hi Malick – thank you very much for raising this interesting point. I was wondering the same thing! However, I do know selling stocks does work because unfortunately I have had to do it several times recently. Perhaps it is just freeing up the capital that satisfies the call ? I will do some more research and amend this in the post! If anyone else understands this could they please comment ? Thanks!

      Russell

      Reply
      1. Malick Bourabah

        Thanks Russell for the prompt reply! I believe the margin call in this case refers to insufficient fund/margin at the settlement date. Selling more stocks will increase the margin again… My 2 pennies…thx

  2. Kyle

    Thanks for the information. I’ve been debating whether I want to be labeled a PDT or not. I’ve traded just enough throughout this year to not be labeled, but I’ve had to wait a day or two here-and-there to buy/sell and lost on a few opportunities. Aren’t some other rules — you must close down all your positions that same day if you are using margin? So no swing trades on margin?

    Reply
    1. barbour2phyrb Post author

      Hi Kyle,

      I have also had these issues with missing opportunities due to the PDT rule. Frustrating isn’t it? You don’t need to close all your positions that same day if you are using margin so swing trading is very doable using margin. If you were to close all positions on the same day you would likely be labelled a PDT very quickly! Does this help ?

      Russell

      Reply
  3. Scott

    Thanks for posting this. The same thing happened to me when I first started trading, and I don’t think it’s emphasized enough to new traders.

    Reply
    1. barbour2phyrb Post author

      Hi Scott, thanks for the feedback! I agree that the details involving PDT are not clearly explained by brokers or clearing firms which is frustrating. Hopefully the industry changes this!

      Good luck trading!

      Reply
  4. Okie

    If you are a pattern DT and your account falls below 25k I strongly recommend you STOP daytrading and penalize yourself by just buying (or shorting) the index and holding until your act goes back above 25k. If you cannot hold the 25k in the first place, you are not going to hold that 25k at all, your act will soon be zero

    Reply
  5. Cam

    Following information is taken directly from FINRA….

    http://www.finra.org/investors/smartinvesting/advancedinvesting/daytrading/p005906

    Summary of the Day-Trading Margin Requirements

    The rules adopt the term “pattern day trader,” which includes any margin customer that day trades (buys then sells or sells short then buys the same security on the same day) four or more times in five business days, provided the number of day trades are more than six percent of the customer’s total trading activity for that same five-day period. Under the rules, a pattern day trader must maintain minimum equity of $25,000 on any day that the customer day trades. The required minimum equity must be in the account prior to any day-trading activities. If the account falls below the $25,000 requirement, the pattern day trader will not be permitted to day trade until the account is restored to the $25,000 minimum equity level.

    FINRA DEFINITIONS FOR PDT:

    What is a day trade?
    Day trading refers to buying then selling or selling short then buying the same security on the same day. Just purchasing a security, without selling it later that same day, would not be considered a day trade.

    Does the rule affect short sales?
    As with current margin rules, all short sales must be done in a margin account. If you sell short and then buy to cover on the same day, it is considered a day trade.

    Does the rule apply to day trading options?
    Yes. The day trading margin rule applies to day trading in any security, including options.

    What is a pattern day trader?
    You will be considered a pattern day trader if you trade four or more times in five business days and your day-trading activities are greater than six percent of your total trading activity for that same five-day period.

    Your brokerage firm also may designate you as a pattern day trader if it knows or has a reasonable basis to believe that you are a pattern day trader. For example, if the firm provided day trading training to you before opening your account, it could designate you as a pattern day trader.

    Would I still be considered a pattern day trader if I engage in four or more day trades in one week, then refrain from day trading the next week?
    In general, once your account has been coded as a pattern day trader, the firm will continue to regard you as a pattern day trader even if you do not day trade for a five-day period. This is because the firm will have a “reasonable belief” that you are a pattern day trader based on your prior trading activities. However, we understand that you may change your trading strategy. You should contact your firm if you have decided to reduce or cease your day trading activities to discuss the appropriate coding of your account.

    Reply
  6. Cam

    $$$***$$$ How to Follow The RULES and Make MONEY too..!! $$$***$$$

    A Margin Call is a real possibility with multiple Swing Positions that when added together CAP-Size a Margin Account. In a swing position the value of your stock can be driven DOWN by the market. If you do not take the loss to close some or all open positions at a loss you may be forced to either ADD money to your account through a cash infusion ACH, wire transfer or as already stated liquidate at least part of one or more positions. This is where a Margin Call / Forced sale has put many under funded & inexperienced traders in the corner with the PDT rule. SIZE DOES MATTER – when it comes to how many Open Trades and the Total Size of ALL Open Trades combined in relation to the Base Funding of the Account Size.

    For example: if you put in $2000 cash in a trading account, you can have it set to be either a cash or margin account. Most brokers give a typical ratio for Margin accounts of 4:1 buying power so $8000 in this example would be available for Trading (My Opinion is that it is best for anyone Learning to remain at or under your funding amount, for this example to keep total position size under $2000 overnight) Most Brokers will state your OVERNIGHT BP (buying power) or Margin Limits must be reduced before closing bell for overnight positions, perhaps 2:1 or $4000 in this example if you are outside the overnight margin requirements you may have positions liquidated at a cost that will include fees added to do this on your behalf.

    The following excerpts have been COPIED directly from the FINRA website:
    ******************************************************
    Day Trading Buying Power
    What is my day-trading buying power under the rules?
    You can trade up to four times your maintenance margin excess as of the close of business of the previous day.

    Does the $25,000 minimum equity requirement have to be 100 percent cash or could it be a combination of cash and securities?
    You can meet the $25,000 minimum equity requirement with a combination of cash and eligible securities.

    Accounts
    Does this rule change apply to cash accounts?
    Day trading in a cash account is generally prohibited. Day trades can occur in a cash account only to the extent the trades do not violate the free-riding prohibition of Federal Reserve Board’s Regulation T. In general, failing to pay for a security before you sell the security in a cash account violates the free-riding prohibition. If you free-ride, your broker is required to place a 90-day freeze on the account.

    Does this rule apply only if I use leverage?
    No, the rule applies to all day trades, whether you use leverage (margin) or not. For example, many options contacts require that you pay for the option in full. As such, there is no leverage used to purchase the options. Nonetheless, if you engage in numerous options transactions during the day you are still subject to intra-day risk. You may not be able to realize the profit on the transaction that you had hoped for and may indeed incur substantial loss due to a pattern of day-trading options. Again, the day trading margin rule is designed to require that funds be in the account where the trading and risk is occurring.

    Can I withdraw funds that I use to meet the minimum equity requirement or day trading margin call immediately after they are deposited?
    No, any funds used to meet the day-trading minimum equity requirement or to meet any day-trading margin calls must remain in your account for two business days following the close of business on any day when the deposit is required.
    ***************************************End of Copy

    Reply
  7. Pingback: 10 things new traders only learn from experience: Tip #1 | My … | How Do I Day Trade?

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