Finance Definitions: Day Trading and Pattern Day Trading

Finance Definitions: Day Trading and Pattern Day Trading

When it comes to general investment terms that could make a difference to you as a stock market investor, day trading is one term that should be defined. This term very well could affect you, and it might come with a few rules and regulations. So let's take a look at day trading.

What is Day Trading?

Let's start by defining day trading. In all its simplicity, day trading means trading a stock more than once in one day. That means that an investor who purchases a stock and sells it on the exact same day is a day trader; an investor who short sells a stock and buys it later that day is also a day trader.

Of course, when you look at the definition, you can obviously see the potential benefits of day trading. A day trader may make a considerable amount of money by trading multiple times in the same day, since we all know that the stock market can vary immensely in any given trading day.

What are the Rules?

First and foremost, when you participate in day trading, you are subject to taxes on your gains. It is therefore important to keep good records of your trades and your gains and losses for that year's tax purposes.

Another major rule in day trading actually pertains to a subset of day trading: pattern day trading. In this type of trading, an investor buys and sells the same security on the same day (or day trades) four or more times within a five business day period. In this type of day trading, there is a 2001 rule established by the U.S. Securities and Exchange Commission (SEC): pattern day traders must keep $25,000 in a brokerage/investment account on trade days, beginning the day before the intended trade. If the funds are not available, a trade cannot take place. Additional rules may apply.

How Does This Affect Me?

These day trading rules may or may not affect you, particularly the pattern day trading rules. If your day trading activity is few and far between, coughing up a $25K retainer is not applicable. However, if your trading intensifies to this pattern day trading level, you should be aware that maintaining a large dollar amount cash account may be a necessity.

Also good to know: if you go through a brokerage or investment firm to participate in your day trading, the firm is required to flag any pattern day trading to the government. Once you're flagged, it may be difficult to be returned to a normal day trading status.

Day trading is a serious job with serious regulations, so before you jump in, you might wish to learn the rules and regulations. Once you know, determining whether day trading or pattern day trading is right for you could be the difference between you and $25,000.

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MoneyCone's picture

MoneyCone wrote:

Mon, 03/26/2012 - 12:48 Comment #: 1

Brokers have additional rules on day trading. Always check with your broker before day trading.

As you rightly point out, day trading is not for everyone and you could lose some serious cash if you are not careful.

Christa Palm's picture

Christa Palm wrote:

Thu, 03/29/2012 - 16:12 Comment #: 2

MoneyCone, great input -- it's very important to clarify the rules with your broker and to be careful in any day trading!