Day trading restrictions on U.S. stocks have been put in place by regulatory authorities to protect individual investors from the risks associated with high-frequency, short-term trading. These restrictions are designed to limit the amount of trading that can be done in a single day, and are enforced by the Financial Industry Regulatory Authority (FINRA).
Day trading involves buying and selling securities on the same day, with the goal of profiting from short-term price movements. This type of trading is often done by professional traders, who use advanced technology and algorithms to execute trades quickly and efficiently.
However, day trading can also be done by individual investors who are looking to make a quick profit. These investors may not have the same level of expertise or resources as professional traders, and may not fully understand the risks involved in day trading.
To protect individual investors, FINRA has implemented several day trading restrictions on U.S. stocks. These restrictions apply to any individual who buys and sells the same security on the same day, or who buys and sells a security multiple times in a single day.
The first day trading restriction is the Pattern Day Trader (PDT) rule. Under this rule, any individual who executes four or more day trades in a five-day period is considered a PDT. Once an individual is classified as a PDT, they must maintain a minimum account balance of $25,000 in order to continue day trading.
This rule is designed to prevent individuals from using their margin accounts to engage in high-frequency, short-term trading. Margin accounts allow investors to borrow money from their broker in order to increase their buying power. However, margin accounts also increase the risk of loss, since investors are using borrowed money to trade.
The PDT rule helps to ensure that investors who are engaging in high-frequency, short-term trading have sufficient funds to cover any losses they may incur. By requiring a minimum account balance of $25,000, FINRA is also limiting the number of individual investors who are able to engage in this type of trading.
Another day trading restriction is the Good Faith Violation (GFV) rule. Under this rule, any individual who buys a security and sells it before the funds used to purchase the security have settled is considered to have committed a GFV.
Settlement is the process by which funds and securities are exchanged between buyers and sellers in a securities transaction. Typically, settlement takes two business days after the trade is executed. Until settlement occurs, the funds used to purchase the security are considered to be in a “pending” state.
If an individual sells a security before the funds used to purchase the security have settled, they are essentially using money that they do not yet have. This is known as a “free ride,” since the investor is able to use the proceeds from the sale of the security to make additional trades before the funds have settled.
The GFV rule helps to prevent free riding by requiring individuals to have sufficient funds in their account to cover the cost of any securities they purchase. If an individual commits a GFV, their broker will issue a warning. If the individual commits three or more GFVs in a 12-month period, their account may be restricted from buying securities for 90 days.
Finally, the Last In, First Out (LIFO) rule is another day trading restriction that applies to U.S. stocks. Under this rule, any individual who buys and sells the same security on the same day must sell the shares they bought last first.
This rule helps to prevent individuals from engaging in what is known as “churning.” Churning involves buying and selling the same security multiple times in a single day in order to generate commissions for the broker. By requiring individuals to sell the shares they bought last first, FINRA is limiting the amount of trading that can be done in a single day.