Margins. Swing traders. Calls. Puts. Wash Sale. Fines.
These are only an infinitesimal fraction of the stock market jargon that traders have to go through and acquaint themselves with. What makes a good trader is not only instinct, luck, and analytical skills, but also the knowledge one has about the trade they’re in. There’s a lot to know about the markets than just the buy and sell.
The Securities and Exchange Commission, the US stock market watchdog, put in its around $ 4 billion worth of fines and disgorgement from 821 transgressions of stock market regulations in 2018. In 2019, the number hit an all-time high of $ 4.3 billion being raked in by the regulator from 861 cases of illegitimate activities.
As newer and more complex financial instruments are being introduced almost every year, stock markets over the world are busy keeping apace with them by analyzing these novelties, identifying the possible lacunae an astute trader might manipulate to increase profits, and formulating new rules to govern the same. As a result, the market is a landmine of rules and regulations.
But an innocuous trader need not burden themselves with unnecessary information. Some of these rules are general, and others are niche. A good run-down of the general conventions, rules, and penalties of the market goes a long way in keeping one out of trouble.
1. Insider Trading
This one is the first whenever traders think of regulations, and has registered many influential people under its violation.
As the stock market runs on people and their whims, and people usually base their actions on their judgment of company performance and profits, any information about the company has the potential to make an impact and direct motives.
Insider trading is self-explanatory. It occurs when one is privy to “material” information about a company, that can change its perception in the public domain and uses that information for making personal gains.
It could be that a company executive knows the poor financial situation of a company, and sells their stocks before the information is out. This preemptive selling would be considered insider trading because the manager has averted losses by way of material information which was not available in the public domain.
Infiltrating a corporate or business entity to gain access to private information, and using it to either book profits or sidestep losses.
2. Day Trades and Margin Calls
While all traders are essentially traders in the market space, there are certain types and kinds which are defined on the basis of their trading patterns, or the money they take for trading.
Margin accounts are those in which traders are loaned money by brokerage firms, called margins, over and above their own money to trade stocks. The value of the stocks maintained in that account is the collateral for the margin. If, for instance, the balance in the margin account falls below a certain stipulated level, the trader receives a margin call to settle the account with the broker.
Pattern Day Traders are defined by the PDT rule, which was implemented in 2001. These are traders who use the margin account for making 4 or more day trades (a day trade is settled automatically at the end of the day) for 5 business days, and they have to maintain a minimum of $ 25,000 in the margin account. Other than that, a pattern day trader is allowed more buying power on margin than a regular margin player.
If a margin account contains a balance of less than $25,000, and the trader inadvertently makes 4 or more day trades for 4 days, more such trades at the final day could result in the account being flagged as a PDT account, and the traders would receive a margin call.
Stock APIs nowadays use algorithms that prevent such trades. They keep a track of all the trades by the trader and signal warning when the account is on the verge of making such a trade that would deem it a day pattern day trading account.
Ignorance of this rule can result in the account being frozen for up to a period of 90 days. Persistent ignorance can result in other stringent repercussions.
3. Taxation of Profits
Buying cheap and selling dear returns in profits, but more often than not, what people don’t tell you is that those profits are taxable. Taxation laws are dense and confusing, and different kinds of profit are subject to different taxation rules.
Long-term gains (earned by selling securities held for more than one year) and short term gains (earned by selling securities within a year) are governed by different laws. Short-term profits are taxed as regular income, whereas long-term profits are taxed at rates lower than those of short-term profits.
Other than that, there are differences based on the kind of assets one earns profits against. For instance, taxes on ETFs and Mutual Fund gains are taxed differently. ETFs are traded passively and are not reassessed as frequently as mutual funds.
Mutual funds, on account of being actively managed, are reassessed on a regular basis, and every time stocks are bought or sold, the tax has to be paid accordingly.
Another tricky tax law is the Wash Sale Rule. It disallows one to balance their short term capital loss against short term capital gains by buying a substantially identical stock within 30 days of selling one at a loss.
Trading regulations and laws are long, obfuscating, and terribly boring, but once you realize that they directly affect the amount of money that’ll end up in your account, you find an appetite for them. Regulation T of the Federal Reserve contains rules pertaining to the regulation of traders and brokers in the stock market.
Other than that, one must go through the various taxation laws and, if interested, learn how to manipulate them to earn more money. Last but not least, one has to keep oneself up to date regarding this matter. Remember, ignorance of the law is a punishable offense.