Flipping in and out of stock may be a great way to scrape small profits off price dips and swells, but unless your stock portfolio account has an equity and cash position of at least $25,000, you will run afoul of the pattern day trader rule.
The pattern day trader rule limits your ability to buy and sell the same stock in the same trading day, unless your account portfolio has a cash and stock value of at least $25,000.
This is just one additional hurdle you need to jump before getting involved in penny stock day trading. This rule stipulates that you must have at least $25,000 in cash or stock value in your portfolio to move in and out of the same security on the same trading day.
Generally, an online broker will allow you to "get away" with one or two trades per week on what they call "both sides of the market," but they could theoretically reject your order requests at any time.
When I was first starting out in this business I had about $5,000 in my account. I came across a stock that was moving up and down in intraday trading and decided to try flipping the stock a few times.
After my third buy and sell transaction that day, I received an alert from my broker. It notified me of the pattern day trader rule, and suggested I deposit $20,000 into my account to meet SEC guidelines.
Right. I had $20,000 setting around looking for a home.
My subsequent attempts to trade on both sides of the market were met with "Cannot accept this order" type messages.
What Exactly Is This Rule?
According to the SEC, a day trader is any trader who buys and sells a particular security in the same trading day and does this four or more times in any five consecutive business day period.
Here's a more legal way of saying basically the same thing:
A pattern day trader is defined in Exchange Rule 431 as any customer who executes 4 or more round-trip day trades within any 5 successive business days. If, however, the number of trades is more than 3 but is 6% or less than the total number of trades that trader has made for that five business day period, the trader will not be considered a pattern day trader and will not be required to meet the $25,000 criteria for a pattern day trader.
More Legalese
According to http://www.patterndaytraderrule.com, this rule is, "this rule applies to anyone who buys and sells a particular security in the same trading day (day trades), and does this four or more times in any five consecutive business day period. A pattern day trader is subject to special rules. The main rule is that in order to engage in pattern day trading you must maintain an equity balance of at least $25,000 in a margin account." Please visit the site referenced above for a complete legal description.
Now that you know more about this rule, you could technically make a few day trades each week without violating SEC rules. However, some authority has been given to online brokers to judge your trading patterns, which could lead to being labeled as a day trader, despite your efforts to trade within the non-pattern day trading rules.
You should also be aware of the "five consecutive business day" comment above. Apparently, the clock does not reset on Monday morning. If you placed several day trades on the previous Friday, these may be a part of the same five day period on Monday.
Why Is There A Pattern Day Trader Rule?
In general terms, the investment community and the Security and Exchange Commission felt the popularity of day trading was causing beginning retail traders to lose too much money in the marketplace. In an effort to curb the day trading mania, they decided a trader should have a minimum account balance before being bale to practice this trading strategy. I guess they figure if you are worth $25,000, you have the knowledge and experience to flip stocks.
I have a different opinion on this. Yes, the SEC may have had your best interests in mind, but I believe (unfounded opinion here) that the institutional investors resented the range bound trading of stocks due to flippers constantly scraping tiny profits off a stock's movement. Imagine a stock is rallying on good news. As the stock rises in value the flippers come into the market. A flipper's mentality (us day traders, that is) is to sell quick, thus deflating the asking price in our hurry to sell out and move along with our small profits.
Flipping can frustrate a stock's move up, which drives the institutional guys wild. Due to their position sizes in a given stock, they cannot move in and out of the stock as quickly as retail traders. When you look at all the money invested in the stock market, keep in mind that about 80% of it is controlled by institutional investors. These are predominantly the mutual funds, pension funds, and insurance companies.
Remember the old saying, "he who has the gold, makes the rules?" Because of their sheer size, the institutional investors get to make the rules-the pattern day trader rule.
What Can I Do About This Rule?
I despise most rules, and see some of this governmental meddling as a slight on the capitalist system. But, I'll save those comments for my college term papers.
The pattern day trader rule may be helpful to some of you. As you build your account value to meet this requirement, learn how to trade and profit on swing trades. The experience you gain as a stock researcher and technical analyst will pay dividends later when you join the fast paced day trading community.