Trading Accounts Explained: What They Are, How They Work, and Examples
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Summary:
Trading accounts are versatile investment accounts that can hold securities, cash, and other assets. They are commonly associated with day traders who engage in frequent buying and selling of assets within the same trading session. This article explores the basics of trading accounts, including their purpose, distinguishing features, and the regulatory framework that governs them. We’ll also delve into the margin requirements set by FINRA for pattern day trading accounts. If you’re considering opening a trading account, understanding these key points is essential.
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What is a trading account?
A trading account is a type of investment account that can contain various assets, including securities, cash, and other holdings. While it can refer to any investment account with tradable assets, it is most commonly associated with day traders. These investors engage in frequent buying and selling of assets, often within the same trading session, and their trading accounts are subject to specific regulations.
The assets held in a trading account are typically separated from those in long-term buy-and-hold investment strategies. This separation helps ensure that the day trader’s activities do not interfere with their long-term investment goals.
Basics of trading account
A trading account functions much like any other brokerage account, allowing investors to hold securities, cash, and various other investment vehicles. It’s worth noting that the term “trading account” can encompass a wide range of accounts, including tax-deferred retirement accounts. However, what distinguishes a trading account from others is the level of activity, the purpose behind that activity, and the associated risks.
In most cases, the activity in a trading account involves day trading. The Financial Industry Regulatory Authority (FINRA) defines a day trade as the purchase and sale of a security within the same trading day, specifically in a margin account. FINRA further identifies pattern day traders as investors who meet the following criteria:
- Traders who execute at least four day trades (buying and selling a stock or selling a stock short and closing that short position) over a five-day week.
- Traders whose day-trading activity accounts for more than 6 percent of their total activity during the same week.
Brokerage firms may also classify clients as pattern day traders based on their previous trading history or other reasonable criteria. Typically, day traders opt for margin accounts, as they provide more leverage for trading. However, it’s important to note that FINRA imposes special margin requirements on pattern day traders.
Opening a trading account
To open a trading account, individuals are required to provide specific personal information, including their social security number and contact details. Depending on the jurisdiction and the brokerage firm’s policies, additional requirements may apply.
FINRA margin requirements for trading accounts
Margin requirements for pattern day trading accounts are notably higher compared to those for non-pattern trading accounts. The Federal Reserve Board’s Regulation T outlines the fundamental requirements for all margin investors, while FINRA introduces additional maintenance requirements for day traders through Rule 4210.
Pattern day traders must maintain a base equity level of $25,000 or 25 percent of their securities values, whichever is higher. Additionally, they are granted purchasing power of up to four times any excess over this minimum requirement. It’s essential to note that equity held in non-trading accounts is not factored into this calculation. If a trader fails to meet these requirements, their broker will issue a margin call, and trading restrictions will be imposed if the call is not covered within five days.
Frequently asked questions
What types of assets can be held in a trading account?
A trading account can hold a variety of assets, including stocks, bonds, options, currencies, and commodities. The specific assets you can trade may depend on the brokerage firm and the type of account you open.
What distinguishes a trading account from other investment accounts?
The primary distinction lies in the level of activity and the purpose of the account. A trading account is typically associated with day trading, involving frequent buying and selling of assets within the same trading day. Other investment accounts, like long-term portfolios, focus on holding assets for extended periods.
What are the margin requirements for pattern day trading accounts?
Pattern day traders are subject to specific margin requirements set by FINRA. They must maintain a minimum base equity level of $25,000 or 25 percent of their securities values, whichever is higher. This equity level is crucial for day traders as it enables them to access leverage for trading.
Key takeaways
- A trading account is a versatile investment account used for trading securities, cash, and other assets.
- Day traders frequently use trading accounts for active buying and selling within the same trading session.
- Pattern day traders must adhere to specific margin requirements, including a minimum equity level of $25,000 or 25 percent of securities values.
- Opening a trading account involves providing personal identification information and meeting the broker’s requirements.
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