Frequent Intraday Trading: Understanding the Basics

If you're an avid trader, you might be pursuing--or thinking about pursuing-- a strategy involving frequent, intraday trading. Investors who actively trade securities, including stocks or options, throughout the day might attempt to profit from small price movements, typically related to volatile stocks, and often make these trades using margin. However, some active investors might choose to implement a frequent trading strategy in cash accounts as well.

The possibility of making rapid returns through this type of trading can be tempting, and online brokerage accounts and apps have made frequent trading more accessible and engaging. However, frequent intraday trading comes with risks--particularly if you're trading on margin--including losing some or all of your investment.

Frequent Trading in a Cash Account

When you buy securities in a cash account, you must pay for securities in full before selling them. Buying and selling the same security in a cash account before paying for it is known as "free-riding," a violation of the Federal Reserve's Regulation T that can lead to strict account restrictions. You can also incur what's known as a "good faith violation" if you purchase a security with cash from a transaction that hasn't settled yet and then sell the security before the proceeds used to fund the purchase have settled.

If you trade frequently in a cash account, be sure that you understand securities settlement cycles and requirements, and that you closely monitor the cash you have available for purchases, to avoid inadvertently committing cash trading violations.

The current settlement time for most equity trades is T+1, or the next business day. Therefore, if you want to engage in intraday trading in a cash account, be sure that you fully pay for those securities at the time of purchase with settled funds.

Frequent Trading in a Margin Account

Many investors who are interested in frequent trading choose to use margin accounts. However, margin trading comes with its own set of risks, including the potential to lose more than your original investment.

To trade using margin (funds borrowed from your firm), you must maintain a minimum of $2,000 in equity in your margin account. Your brokerage firm may require higher minimum equity amounts--often called "house" requirements--depending on the firm's policies and your account activity.

When trading on margin during the day, intraday margin requirements will apply. These are margin calculations based on your positions during the trading day, not just at the end of the day. Your brokerage firm monitors your account to ensure that you maintain adequate equity relative to your trading positions.

If your account doesn't have enough equity to meet requirements, you have an "intraday margin deficit," and your firm will expect you to satisfy the deficit as promptly as possible by depositing funds or liquidating positions.

If you make a practice of creating intraday margin deficits and failing to satisfy them promptly, your firm may need to freeze your account from trading on margin for 90 days or until the deficit is satisfied, whichever comes first.

Considerations Before Using a Frequent Trading Strategy

While frequent intraday trading can offer the potential to profit from rapid shifts in the market, it also involves potential losses. Markets can be unpredictable, and security prices might not move in the direction you expect. Attempting to capture profits in the short term is generally less reliable than investing long-term.

Frequent trading can also come with higher costs that might erode your returns, as well as potential tax implications. Additionally, trading throughout the day is time-intensive and requires that you pay continuous attention to your holdings and the market as a whole.

Further, if you trade using margin, you should be prepared to lose some of--and potentially more than--the funds you initially deposited in your account for this purpose. Given the significant risks, you should never fund this type of trading with essential assets.

Strategies that involve frequent trading on margin generally are not appropriate for investors with:

• limited financial resources;
• limited investment or trading experience; or
• low risk tolerance.

The Bottom Line

If you're considering a frequent, intraday trading strategy, carefully evaluate whether this investment strategy is a fit for your financial goals and risk tolerance. In addition, make sure you understand the following:

• Market Dynamics – how securities markets work and what affects security prices
• Your Firm's Systems – how your brokerage firm executes orders and manages risk
• Margin Rules – how margin calculations work and what happens if you create a deficit
• Trading Costs – commissions, fees and other costs associated with frequent trading
• Tax Implications – how frequent trading might affect your taxes

Before you engage in this type of trading, consider what type of account you'll use and what percentage of your total investment funds you'll allocate to this strategy. If you choose to implement a frequent trading strategy in a cash account, stay vigilant to ensure that you don't incur trading violations. To trade using margin, you'll need to have adequate capital and meet intraday margin requirements. Talk to your brokerage firm about how intraday margin requirements work in your specific account and have a plan to satisfy any deficits that might occur.

Consider working with an investment professional to help you determine the best investment strategy to achieve your individual financial goals. Also, talk with a tax professional to understand how frequent trading could impact your taxes.

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