Account trading definition
Banks are companies that assist other companies in raising financial capital, transacting foreign currency exchange, and managing financial risks. Trading has historically been associated with large banks, because they are often required to make a market to facilitate the services they provide e.
For example, if General Store Co. The investment bank agrees to buy the shares sold and look for a buyer. This provides liquidity to the markets. The bank normally does not care about the fundamental, intrinsic value of the shares, but only that it can sell them at a slightly higher price than it could buy them.
To do this, an investment bank employs traders. Over time these traders began to devise different strategies within this system to earn even more profit independent of providing client liquidity, and this is how proprietary trading was born. The evolution of proprietary trading at banks reached the point where many banks employed multiple traders devoted solely to proprietary trading, with the hopes of earning added profits above that of market-making.
These proprietary trading desks were often considered internal hedge funds within the bank, performing in isolation away from client-flow traders.
Proprietary desks routinely had the highest value at risk among other trading desks at the bank. At times, investment banks such as Goldman Sachs , Deutsche Bank , and the former Merrill Lynch earned a significant portion of their quarterly and annual profits and losses through proprietary trading efforts. Regulatory bodies worldwide require that the proprietary trading desk is kept separate from its client-related activity and trading.
This is achieved by the use of information barriers also known as " Chinese walls " , which prevent conflict of interest which might, for example, allow a Bank to front-run its own customers. There often exists confusion between proprietary positions held by market-making desks sometimes referred to as warehoused risk and desks specifically assigned the task of proprietary trading. Because of recent financial regulations like the Volcker Rule in particular, most major banks have spun off their prop trading desks or shut them down altogether.
It is carried out at specialized prop trading firms and hedge funds. The prop trading done at these firms is usually highly technology-driven, utilizing complex quantitative models and algorithms. One of the main strategies of trading, traditionally associated with banks, is arbitrage. In the most basic sense, arbitrage is defined as taking advantage of a price discrepancy through the purchase or sale of certain combinations of securities to lock in a market-neutral profit.
The trade will remain subject to various non-market risks, such as settlement risk and other operational risks. Investment banks, which are often active in many markets around the world, constantly watch for arbitrage opportunities. One of the more-notable areas of arbitrage, called risk arbitrage or merger arbitrage, evolved in the s.
When a company plans to buy another company, often the share price of the buyer falls because the buyer will have to pay money to buy the other company and the share price of the purchased company rises because the buyer usually buys those shares at a price higher than the current price. When an investment bank believes a buyout is imminent, it often sells short the shares of the buyer betting that the price will go down and buys the shares of the company being acquired betting the price will go up.
There are a number of ways in which proprietary trading can create conflicts of interest between a bank's interests and those of its customers. As investment banks are key figures in mergers and acquisitions, it is possible though prohibited for traders to use inside information to engage in merger arbitrage.
Investment banks are required to have a Chinese wall separating their trading and investment banking divisions; however, in recent years, especially since the Enron scandal , these have come under closer scrutiny. One example of an alleged conflict of interest can be found in charges brought by the Australian Securities and Investment Commission against Citigroup in This is because the firm will have a "reasonable belief" that you are a pattern day trader based on your prior trading activities.
However, we understand that you may change your trading strategy. You should contact your firm if you have decided to reduce or cease your day trading activities to discuss the appropriate coding of your account. This collateral could be sold out if the securities declined substantially in value and were subject to a margin call. The typical day trader, however, is flat at the end of the day i. Therefore, there is no collateral for the brokerage firm to sell out to meet margin requirements and collateral must be obtained by other means.
Accordingly, the higher minimum equity requirement for day trading provides the brokerage firm a cushion to meet any deficiencies in the account resulting from day trading. The credit arrangements for day-trading margin accounts involve two parties -- the brokerage firm processing the trades and the customer.
The brokerage firm is the lender and the customer is the borrower. No, you can't use a cross-guarantee to meet any of the day-trading margin requirements. Each day-trading account is required to meet the minimum equity requirement independently, using only the financial resources available in the account.
What happens if the equity in my account falls below the minimum equity requirement? I'm always flat at the end of the day. Why do I have to fund my account at all? Why can't I just trade stocks, have the brokerage firm mail me a check for my profits or, if I lose money, I'll mail the firm a check for my losses? It is saying you should be able to trade solely on the firm's money without putting up any of your own funds.
This type of activity is prohibited, as it would put your firm and indeed the U. The money must be in the brokerage account because that is where the trading and risk is occurring. These funds are required to support the risks associated with day-trading activities. You can trade up to four times your maintenance margin excess as of the close of business of the previous day.
You should contact your brokerage firm to obtain more information on whether it imposes more stringent margin requirements. If you exceed your day-trading buying power limitations, your brokerage firm will issue a day-trading margin call to you.
Until the margin call is met, your day-trading account will be restricted to day-trading buying power of only two times maintenance margin excess based on your daily total trading commitment. Day trading in a cash account is generally prohibited. Day trades can occur in a cash account only to the extent the trades do not violate the free-riding prohibition of Federal Reserve Board's Regulation T.
In general, failing to pay for a security before you sell the security in a cash account violates the free-riding prohibition. If you free-ride, your broker is required to place a day freeze on the account. No, the rule applies to all day trades, whether you use leverage margin or not. For example, many options contracts require that you pay for the option in full.
As such, there is no leverage used to purchase the options. Nonetheless, if you engage in numerous options transactions during the day you are still subject to intra-day risk. You may not be able to realize the profit on the transaction that you had hoped for and may indeed incur substantial loss due to a pattern of day-trading options. Again, the day-trading margin rule is designed to require that funds be in the account where the trading and risk is occurring.
Can I withdraw funds that I use to meet the minimum equity requirement or day-trading margin call immediately after they are deposited? No, any funds used to meet the day-trading minimum equity requirement or to meet any day-trading margin calls must remain in your account for two business days following the close of business on any day when the deposit is required.