How to Manage Risk in Margin Agreements while Day Trading - dummies

How to Manage Risk in Margin Agreements while Day Trading

If you qualify as a pattern day trader, you get two benefits. First, your brokerage firm probably won’t charge you any interest as long as you do not hold a margin loan balance overnight. Second, you may be allowed to borrow more than 50 percent of the purchase price of securities. Some firms allow pattern day traders to borrow 75 percent or more of their trade value.

The Financial Industries Regulatory Association defines a pattern day trader as one with a margin account holding at least $25,000. This trader must also buy then sell, or sell short then buy, the same security on the same day four or more times in five business days. The number of day trades should be more than 6 percent of the customer’s total trading activity for that same five-day period.

Also, day traders are often able to avoid margin calls because they borrow money for such short periods of time. Good day traders look for small market moves and cut their losses early, which minimizes the risk of using other people’s money. And by definition, day traders close out their positions every night.

If the value of your account starts falling and it looks like it’s falling below the 25-percent maintenance margin limit, you will get a margin call, in which your broker calls you and asks you to deposit more money in your account.

If you can’t make the necessary deposit, the broker starts selling your securities to close out the loan. And if you don’t have enough to pay off the loan, the broker closes your account and puts a lien, which is a claim on your assets, against you.

Most brokerage firms have risk-management limits in place, so you’ll probably get plenty of warning before you get a margin call or see your account closed out. After all, neither you nor your brokerage firm wants to lose money. Just keep in mind that a margin call is a possibility.

If your account falls to the maintenance level, ask yourself, as objectively as you can, whether your idea is still good or whether you’re just wishing and hoping that it is.

At least one brokerage firm advertises that, as a service to you, it will close out your account as soon as you lose the amount in it in order to keep you from losing more money. This service helps the brokerage firm as much as it helps you, because it keeps the firm from dealing with the hassles of chasing down additional margin.