The Pattern Day Trader.

In the past, day trading represented the Wild West of the market. It was possible for day traders to move in and out of positions within the trading day and end up with no open positions. This meant it was possible to trade on large volume with little or no cash at risk, meaning no margin requirements. It also meant huge risks for brokers.

For some traders, the whole idea of day trading was a path to easy riches with no risk. It was the fad of the day and it worked -- until the market turned and fell, meaning a lot of portfolios based on accumulated day trades collapsed. And as most traders know, market prices tend to fall more rapidly than they rise.

Trading on such extreme leverage is an attractive idea, but it's not the only motive for day trading. Many traders believe that the risk of price gaps between today’s close and tomorrow’s open are simply too great; day trading enables traders to close out positions during the trading day, avoiding this risk altogether. Even so, if you want to day trade, you could fall into the definition of a “pattern day trader.”

Day trading relies on a high frequency of trades in very short timeframes measured not in days but in seconds. The entry/exit decision is based on momentum, chart patterns, and other technical strategies. Whichever strategy employed, the theme to day trading is that positions close before the trading day’s end. Margin requirements are calculated based on open positions at the end of the day; so day traders following the system end up with no open positions and no margin calls.

This problem, at times representing unacceptable risks to brokers as well as to traders, is what led to the need for enactment of new rules concerning so-called pattern day traders. By definition, you're a pattern day trader if you buy or sell a security within the same day, and follow this pattern four or more times within five consecutive trading days. If you do fall into this definition, you must maintain high margins in equity balances (cash and securities) in your margin account. This balance has to be on hand before you can continue any day trading, once you reach that threshold.