There are various day trading rules that you must follow, regardless of the market you are trading in – be it stocks, forex, futures, options, or cryptocurrency. Ignoring these rules can be quite costly, so it is essential to pay attention to them if you want to remain profitable.
While the specific rules may differ by location and trading volume, this page covers some of the most crucial ones, such as those related to pattern day trading and trading accounts. It also highlights rules that both novice and seasoned traders can use to improve their trading performance, such as risk management.
Margin Requirements for Pattern Day Traders
If you live in the United States, one of the most critical rules concerns whether you qualify as a ‘pattern day trader.’ These regulations are established by the Financial Industry Regulatory Authority (FINRA) and apply to all pattern day traders in the US who hold a margin account. The rules focus on traders with less than or more than $25k, whether they trade in the Nasdaq or other markets.
Pattern Day Trader
So, what exactly is a ‘pattern day trader (PDT)?’ If you make more than three day trades in five business days and the number of trades is over 6% of the total trades in your account during that period, you meet the minimum criteria.
What Counts as a Day Trade?
The number of trades you make is critical in these calculations, so you must have a thorough understanding of what qualifies as a day trade. A day trade is simply two transactions in the same instrument in the same trading day – for example, buying and then selling a stock.
The two transactions must off-set each other to meet the definition of a day trade for the PDT requirements. So, if you hold any position overnight, it is not a day trade.
Number Of Trades
The total quantity of shares can sometimes confuse individuals, greying the rules and leading to costly mistakes. Below are several examples to highlight the point.
- If you enter a stock position with a single order of 2000 shares and exit the position with two 1000 share orders, all three trades will be grouped together as one day trade.
- This is the same the other way around. If you open a position with two 1000 share orders and close your position with one order of 2000 trades, again this will be considered one day trade.
- Say you opened with two 400 share trade orders and closed with two 400 share orders. This would constitute two day trades, not one, as you would have two transactions at either end.
Once you’ve met these criteria and are considered a pattern trader, there are certain rules and stipulations you must follow:
- Minimum account balance – The most demanding is holding an account balance of at least $25,000. If the total value of assets falls below that figure you will not have any buying power. It is also worth noting you cannot meet this requirement by cross-guaranteeing separate accounts. You can, however, meet this minimum requirement with a combination of eligible cash and securities.
- Existing sale conditions – Note the sale of an existing position from the previous day and its subsequent repurchase is not considered a day trade.
- Buying power – Your day trading power will be four times the New York Stock Exchange (NYSE) excess as of the close of business on the previous day.
The ‘time and tick’ method of calculating day trading is acceptable.
If you exceed this limitation a margin call will be issued.
- Outstanding margin call – If the account already has an outstanding margin call, your buying power will be reduced to just two times the NYSE excess.
- In addition, the ‘time and tick’ calculation technique cannot be used whilst the margin call remains outstanding.
- Instead, the aggregate method, which uses the total of all day trades will be used.
- Failure to meet margin call – If you fail to meet a margin call for more funds within five business days, your buying power will be further reduced to just one times the NYSE excess for ninety days (cash trades only), until you’ve met the call.
- Minimum requirements – When you deposit funds to meet minimum equity requirements or to meet margin calls the funds must remain in your account without withdrawals for at least two business days.
Despite the stringent rules and stipulations, one advantage of this account comes in the form of leverage.
Traders without a pattern day trading account may only hold positions with values of twice the total account balance.
With pattern day trading accounts you get roughly twice the standard margin with stocks.
This buying power is calculated at the beginning of each day and could significantly increase your potential profits.
However, it is worth highlighting that this will also magnify losses.
You could, in fact, lose more than your initial investment, and if you can’t subsidise that promptly your broker may liquidate your position.
A Title Hard To Shake
It is also worth bearing in mind that if the broker provided you with day trading training before you opened your account, you may be automatically coded as a day trader. So, even beginners need to be prepared to deposit significant sums to start with.
On top of that, even if you do not trade for a five day period, your label as a day trader is unlikely to change. Your broker will retain a ‘reasonable belief’ that you are a pattern day trader based on your previous activities.
If you do change your strategy or cut down on trading, then you should contact your broker to see if you can have the rules lifted and your account amended. In conclusion
Is The Rule Applicable To Cash Accounts?
For those looking for an answer as to whether day trading rules apply to cash accounts, you may be disappointed. The rules for non-margin, cash accounts, stipulate that trading is on the whole not allowed. They are allowed only to the extent that the trades do not violate the free-riding prohibitions of Federal Reserve Board’s Regulation T.
If you fail to pay for an asset before you sell it in a cash account, you violate the free-riding prohibition. This complies the broker to enforce a 90-day freeze on your account.
Is The Rule Applicable To Options?
To answer the question on every options trader’s lips, do pattern day trading rules apply to options?
The answer is affirmative, they do.
Regrettably, those who are hoping for a relaxation of the steep minimum requirements will not find any refuge. However, as our options page indicates, there are other advantages that come with exploring options.
Finally, the pattern day rules do not apply to the UK, Canada, or any other country. These rules are established by the US FNRA and, as a result, are only applicable in the United States.
In addition to the rules surrounding pattern trading, there is another important rule to be aware of in the United States. The IRS has established this straightforward rule, which prohibits traders from claiming losses for the trade sale of a security in a wash sale.
A wash-sale occurs when a security is traded at a loss, and within thirty days before or after this sale, you purchase a “substantially identical” stock or security, or an option to do so. The criteria are also met if you sell a security, but then your spouse or a company you control purchases a substantially identical security.
If the IRS disallows a loss as a result of the wash sale rule, you must add the loss to the cost of the new stock. This will then become the cost basis for the new stock.
For instance, suppose you purchased 200 shares in Amazon for $30 each, sold the shares at $25, resulting in a capital loss of $1,000. Then, two weeks later, you purchased 200 shares at $27, which you subsequently sold a week later for $37 per share. Your net loss on the wash sale would be the $5,000 sale proceeds minus the $6,000, plus the $1,000 adjustment, which equals $0.
You would then add the $1,000 disallowed loss to the $5,400 cost of the shares.
Your capital gain is calculated by subtracting the adjusted cost from the sale proceeds. In this case, your gain would be $1,000 ($7,400 – $6,400). However, if you had a loss on a wash sale, you can reduce your gain on the second sale by that amount.
Traders often wonder if day trading rules apply to different types of trading, such as forex, stocks, options, and futures. The truth is that rules may vary depending on your broker and account type.
Most brokers offer different types of accounts, including cash and margin accounts. Each account has its own set of rules and regulations that you must follow.
Before opening an account with a new broker, it’s important to investigate the following rules:
- Minimum deposit – Some brokers require a higher minimum deposit than others. This can make some brokers unaffordable for some traders. Beginners may want to look for brokers with lower minimums.
- Daily trading limit – Limits are often used to prevent market manipulation and limit losses. Different brokers may impose different daily trading limits. For example, TradeStation and Scottrade may have higher limits than Interactive Brokers and TD Ameritrade.
- Margin & leverage – A cash account will not allow you to borrow capital from your broker. Margin accounts allow for borrowing, but have their own specific rules and limitations.
Sign up for a margin account, however, and you’ll be allowed to borrow a certain amount to capitalise on trades, increasing your potential profits. Brokers will have different rules around how much margin you can have access to. JB and ASX rules may vary from Etrade, for example.
For more guidance, see our brokers page.
Rules For Beginners
If you’re new to the arena, following these 7 golden rules of day trading could help you turn handsome profits and avoid expensive pitfalls.
1. Enter, Exit & Escape
One of the biggest mistakes novices make is not having a game plan. Don’t even think about hitting the ‘enter’ key until you know when to get in and out. Understandably, excitement can be running high when you’re new to the game. However, you’ll quickly find yourself out of the game entirely if you don’t plan your trades carefully. Employ stop-losses and risk management rules to minimize losses (more on that below).
You’re up bright and early for the day ahead and you’re eager to start entering positions. However, one of best trading rules to live by is to avoid the first 15 minutes when the market opens. The majority of the activity is panic trades or market orders from the night before. Instead, use this time to keep an eye out for reversals. Even a lot of experienced traders avoid the first 15 minutes.
3.Be Wary Of Margin
In those early days when you’re struggling for capital, it’s easy to be swayed by margin.
However, it’s important to evaluate tips before acting on them.Be sure to research and consider the source of the tip and its potential impact on your trading strategy.Remember, not all tips are created equal, and blindly following them can lead to costly mistakes.
Discipline is key to successful trading. Stick to your strategy and trading plan, and don’t let emotions or impulses guide your decisions.Keep a cool head and stay focused on your goals, and you’ll be better equipped to navigate the ups and downs of the markets.
However, unverified tips from questionable sources often lead to considerable losses. As trader Jesse Livermore once said, “I know from experience that nobody can give me a tip or a series of tips that will make more money for me than my own judgment.” So, make sure you check and double check all tips and information that may influence your trading decisions.
For more general guidance, see our tips page.
Risk Management Rules
Day trading risk and money management rules will determine how successful an intraday trader you will be. Whilst you do not have to follow these risk management rules to the letter, they have proved invaluable for many.
1% Risk Rule
The idea is to prevent you ever trading more than you can afford. Using this technique, regardless of how wrong a trade goes, you’ll always have more in the bank to rectify your balance at a later date.
The idea is simply that you never trade more than 1% of your account on a single trade. So, if you have $50,000 in your account, you’d trade up to $500 on a single trade.
Why Use It?
You’d have to lose 100 trades in a row to clear your entire balance. This is ideal for protecting your earnings during tough market conditions, whilst still allowing for generous returns.
On the returns side, you may be worried that you’ll never turn enough profit trading so little. But you certainly can. If you risk 1% your profit expectation should be around 1.5% – 2%.
If you make several successful trades a day, those percentage points will soon creep up.
It’s an ideal system for beginners. Whilst you learn through trial and error, losses can come thick and fast. This system will keep you in the game until you’re a trading veteran armed with effective techniques for turning intraday profit.
Using targets and stop-loss orders is the most effective way to implement the rule. Let’s say you want to buy a stock for $20 and you have $40,000 in your account. On your chart, you may see the price recently experienced a short-term swing low at $19.90. You’d place your stop-loss at $19.89, one percent below the recent low.
With your stop-loss in place, you can work out how many shares you can trade without losing over 1% of your account. So, you’d do 1% of $40,000 which is $400. This is your account risk. Your trade risk is $0.11, the difference between your entry price and stop-loss.
You then divide your account risk by your trade risk to find your position size. So, $400/$0.11 = 3636 shares. You could then round this down to 3,600. You now enter your position safe in the knowledge that your maximum loss will be just 1% of your balance.
Once you’ve established an effective technique you can amend your risk tolerance. You can up it to 1.5% or 2%. It’s also worth noting traders with over $100,000 in their account may want to risk less than 1% on a single trade, as even 1% losses could then be significant.
Ultimately, it’s about finding a point that’s comfortable for you and compliments your trading style.
Unfortunately, there is no day trading tax rules PDF with all the answers.
Instead, income tax rules will vary hugely depending on where you’re based and what you’re trading. Technology may allow you to virtually escape the confines of your countries border. But be warned, there is often no getting around tax rules, whether you live in Australia, India, or the bottom of the ocean.
Each country will impose different tax obligations. The consequences for not meeting those can be extremely costly. Day trading rules for the IRS will differ to those set out by the HMRC, for example.
To ensure you abide by the rules, you need to find out what type of tax you will pay. Will it be personal income tax, capital gains tax, business tax, etc? In addition, will you pay tax domestically and/or abroad?
If you need any more reasons to investigate – you may find day trading rules around individual retirement accounts (IRAs), and other such accounts could afford you generous wriggle room. So, it is in your interest to do your homework.
For more guidance, see our taxes page.
Intraday trading rules and regulations vary depending on where you’re trading, how you’re trading and what you’re trading. Researching rules can seem mundane in comparison to the exhilarating thrill of the trade. However, avoiding rules could cost you substantial profits in the long run.