Day Trading Rules and Tips for All Beginners
If you’re new to it, it’s important to brush up on or learn the regulations and rules for day trading. The pattern day trading rule, for example, prevents you from making unfavorable moves within the stock market that could get you out of the game altogether. When you abide by day trading rules, you can make more strategic decisions and reduce your risk of substantial losses. Use this guide to learn more about pattern day trading, the various day trading rules, and tips to help you do well.
- Day trading refers to the purchasing and selling of the same security within a single day in a margin account.
- Pattern day trading involves making four or more day trades in a five-day business period with a margin account.
- As a pattern day trader, you can trade up to four times in the margin account as of the close of business on the previous day.
What Is Day Trading?
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Day trading refers to the buying and selling of the same security within a single day in a margin account. Using various techniques and strategies, day traders aim to profit off an asset’s price changes when day trading. To avoid unmanageable risks, day traders exit positions prior to the market closing. They must remain objective and self-disciplined to take advantage of market insufficiencies. They also need to have a good amount of capital, decent marketplace experience, and plenty of strategies to utilize.
What Is Pattern Day Trading?
Pattern day trading involves making four or more day trades in a five-day business period with a margin account. Pattern day traders must ensure the day trades make up over 6% of the account’s entire trade activity during this five-day timeframe. When this happens, the broker flags the trader’s account as a pattern day trader. Having this designation places various restrictions on future trading in an effort to avoid excessive trading.
What Are the Rules for Pattern Day Traders?
There are two margin rules when it comes to day trading: The pattern day trader rule and buying power limitation. Here’s an in-depth look at each of these rules:
Pattern Day Trader Rule
Set in place by the Financial Industry Regulatory Authority, the pattern day trader rule requires pattern day traders to have at least $25,000 of equity in a margin account to reduce any risk. When pattern day traders don’t have the equity minimum of $25,000 in their margin accounts, they’re subject to a pattern day trader penalty. Essentially, they can’t make additional day trades until they restore this balance.
Make sure the funds you use to meet the day trading requirement or margin calls stay in your account for two days after the close of business on the day you made the deposit. To meet the requirement, you can have a combination of both cash and eligible securities.
It’s worth noting that despite the fact that the pattern day trader rule extends across the industry, individual brokerage firms may be more strict with them. If you inadvertently get flagged as a day trader and don’t plan to day trade in the future, contact your broker to help you avoid repercussions.
Buying Power Limitation
As a pattern day trader, you can trade up to four times in the margin account as of the close of business on the previous day. If you don’t, you’ll receive a day trading margin call from the firm. During these circumstances, you have five business days to deposit funds to meet the call. In the meantime, you’re restricted to a day trading buying power of two times (rather than four times) the maintenance margin excess.
Tips for Pattern Day Trading
Navigating the stock market as a new day trader can be tricky. Use these day trader tips to help you navigate the market as a rookie:
- Be realistic. If you’re about to make a trade, don’t miss out on a decent gain in your quest for a greater profit. After all, making a small profit is better than incurring a loss. Even small trades can help you gain more experience and confidence.
- Gain knowledge. Learn more about basic trading procedures and the stocks you’re interested in. For example, if you’re eyeing a particular stock, look into a company’s financials and reports to determine if it’s a worthwhile trade. You should also track the state of the stock market and events that could affect stocks. Visiting financial websites and proper research can help you make more informed decisions when it comes to day trading.
- Set aside and distribute funds. Determine how much you’re willing to risk on an individual trade to manage your capital. You can also set aside funds you’re okay trading.
- Make the time. Since day trading requires a significant amount of time, make sure you have it to spare. Opportunities can arise at any time, so it’s important to be ready to act at any given second.
- Start small. As a new day trader, focus on one or two stocks. This helps you to better track and find worthwhile opportunities.
What Are Some Day-Trading Loopholes?
If you don’t have the $25,000 needed for day trading activities, there are some ways around the requirement. Though they’re not ideal, certain loopholes and strategies can help you under these circumstances. Here are some day trading loopholes to consider:
- Make three day trades within five days. Since you get flagged once you hit four trades within this timeframe, aim for just a day shy of that. Keep in mind that this loophole means you have to choose valid trade signals.
- Trade outside of the U.S. If you have a broker that’s outside of the U.S., consider day trading within a foreign stock market. These markets may have different rules or account minimums for you to abide by. If you opt for this loophole, research other markets and confer with both tax and legal professionals to better understand what you’re getting into.
- Work with a day trader firm. These firms often let you deposit capital that’s much lower than the $25,000 requirement. Then, they give you additional capital for your day trading activities. The deposit you provide prevents them from losses you incur. These firms can also leverage your capital.
- Try swing trading. Instead of day trading, engage in trading for more than a day. Swing traders capture trends that extend over days or weeks. Even if you don’t have enough equity for day trading, swing trading can help you stay active and in the trading game.
- Open multiple day trading accounts. While this isn’t ideal, you can always open multiple accounts with different brokers. For example, if you have two accounts with different brokers, you can technically make three day trades with each account. However, if you don’t have much capital, day trading with these accounts won’t produce much income. In addition, small amounts of capital limit the amount of stocks you can trade, and brokers may not be willing to accept such small deposits.
What Benefits Do Pattern Day Traders Receive?
Despite the restrictions that pattern day traders face, they’re also presented with several benefits, depending on how you look at it. Here are some advantages of being a pattern day trader:
When you meet the equity requirement, you gain the option of trading with additional leverage. In other words, you can trade with borrowed money to make bigger bets. As opposed to stock investors who trade with a maximum leverage of 2:1, a stock trader can trade with a 4:1 leverage. This means you can make investments worth four times the excess equity value that is in your account. This greater leverage allows you to benefit from returns that are four times greater than if you only used your own capital.
Prevents Losing Everything All at Once
If you look at it from another angle, the restrictions from the pattern day trader rule provide you with another hidden benefit. If you’re new to the stock market, trading rules can prevent you from making a massive mistake. For example, if you lose money, additional trading could lead to further losses. Having rules in place ensures you don’t blow up your account all at once. The pattern day trader rule can ultimately encourage you to grow your account steadily over time in order to achieve consistent profits.
More Time to Study
Don’t just assume that you can get rich quickly. Instead of overtrading, use the time you have to study up on trading and the various techniques you can implement. When you spend time learning the basics and taking it slow, you can make more strategic trades and potentially make greater profits.
Why Is There a Pattern Day Trader Rule?
As stated previously, the pattern day trader rule aims to prevent overtrading. The $25,000 requirement also ensures that there’s enough equity to support risks that result from day trading.
Now that you understand the various rules that come with day trading, ensure that you’re sticking to these regulations during your trading activities. When you abide by these rules, it can help set you up for success.