If your brokerage account has been designated as a pattern day trading account, you benefit from a higher level of potential margin loan leverage, often referred to as buying power. The state in which you leave your trading account at the end of the day sets up your buying power limits for the next day.
Pattern Day Trading Account
Securities and Exchange Commission rules require that a brokerage account be designated as a pattern day trading account if more than four day trades are made in any five business day period. A day trade is the purchase and sale of a stock or other security during the same market day. When your brokerage margin account becomes designated as a pattern day trading account, the margin rules change for the account. The minimum equity requirement -- the amount of your money that must be in the account -- increases to $25,000 from $2,000. The amount of available leverage also increases, providing what is commonly referred to as buying power.
Trading With Margin
A brokerage margin account allows you to borrow a portion of the cost of buying stocks. Day trading can only be done in a margin account. A regular margin account allows you to finance 50 percent of the cost of stocks, giving you two times your equity in buying power. A pattern day trading account is allowed to buy and sell using a 25 percent equity level, giving the day trader four times equity buying power.
Pure Day Trading Buying Power
If you only day trade stocks and close out each day with your account all in cash -- flat, in trader jargon -- your day trading buying power will be four times the closing balance of your account on the previous trading day. For example, if your previous closing balance was $40,000, you could have up to $160,000 worth of open day trades during the current market day. Any additional deposits made to your account overnight or during the current trading day do not increase the buying power level for the current day.
Carrying a Margin Loan Balance
If your trading style includes carrying some positions and associated margin loan balance overnight, the day trading buying power calculation becomes a little more complicated. The SEC defines buying power in these circumstances as four times your equity above the standard 25 percent maintenance margin requirement. Lets say your account overnight had $60,000 in cash and stocks with a $10,000 margin loan, leaving an equity amount of $50,000. The 25 percent maintenance margin on $60,000 would be $15,000, which when subtracted from the equity leaves excess equity of $35,000. Multiply this number by four for a day trading buying power number of $140,000.
Monitoring Your Buying Power
The online account screen of your brokerage day trading account will show your equity, cash balances and buying power before you start trading for the day and balance of buying power throughout the market day. Your broker has the right to require higher margin and equity amounts than the minimums required by the SEC. As the market day ends, close out enough trades so any margin loan carried to the next day is as small as possible and your net equity is above the $25,000 or broker-set minimum.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelors degree in mathematics from the U.S. Air Force Academy.