Buying and trading stocks in a brokerage margin account allows you to increase the returns on your invested money. While a margin account gives you added flexibility, borrowing money to buy stocks can get you in trouble if you do not understand the margin rules. The Securities and Exchange Commission has set different margin rules for day-trading and the maintenance margin for holding stocks overnight.
Day trading is the buying and selling of stocks during a single market day. At the end of the day, the typical day trader has his account back to 100 percent cash. An investor who day trades in his brokerage account will have the account designated as a pattern day trading account and be subject to a specific set of rules. An investor who buys stocks on the margin and holds the shares for longer than a day buys and sells under the standard margin account rules. If a day trader elects to hold some stock positions after the market closes, the standard margin rules -- including maintenance margin requirements -- would then apply until the market opens again for the next trading day.
The standard margin rules allow an investor to use a margin loan to pay for up to 50 percent of the cost of purchased stocks. Another way to look at it is that the investor can buy twice as much stock as she has equity in the account. If stocks purchased on margin decline in value, the loss comes out of the trader's equity, reducing the percentage of the account that is not margin loan. The maintenance margin minimum is 25 percent investor equity. If the equity falls below the 25 percent, the investor will receive a margin call and be required to add more money or sell some stocks to pay down the margin loan.
Day Trading Margin
The day trading margin rules allow the trader to have up to four times equity purchasing power for trading. If the trader starts the day with $50,000 of equity -- usually cash -- he can have open stock trading positions worth up to $200,000 at any point during the trading day. This is twice as high as the regular margin rules allowing a 50 percent margin loan to buy stocks. At the end of the trading day, a designated pattern day trading account must have at least $25,000 of equity to be allowed to day trade the next day.
The sharp observer will note that the 25 percent maintenance margin requires the same level of equity as the four times day trading buying power. The difference is the maintenance margin is reached due to falling stock values in a margin account and the day trader can get there by buying shares on the margin. It is possible a day trader could carry a four times leveraged position overnight as a 25 percent maintenance margin. However, there would be no equity to trade with the next day -- defeating the purpose of having a designated day trading account.
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 bachelor's degree in mathematics from the U.S. Air Force Academy.