Rules

There are a number of different day trading rules you need to be aware of, regardless of whether you’re trading stocks, forex, futures, options, or cryptocurrency. Failure to adhere to certain rules could cost you considerably. So, pay attention if you want to stay firmly in the black.

Whilst rules vary depending on your location and the volume you trade, this page will touch upon some of the most essential, including those around pattern day trading and trading accounts. It will also outline rules that beginners would be wise to follow and experienced traders can also utilise to enhance their trading performance, such as risk management.

USA

Margin Requirements For Pattern Day Traders

If you reside in the US, one of the most important rules concerns whether you fall into the category of a ‘pattern day trader.’ These rules and stipulations are born from the Financial Industry Regulation Authority (FINRA) and are applicable to all pattern day traders in the US who hold a margin account. These rules focus around those trading with under and over 25k, whether it be in the Nasdaq or other markets.

Pattern Day Trader

So, what is a ‘pattern day trader (PTD)?’ If you make more than three day trades in five business days, provided the number of trades is more than 6% of total trades in your account during this period, you meet the minimum criteria.

What Constitutes A Day Trade?

The number of trades plays a crucial role in these calculations, so you need a comprehensive understanding of what counts as a day trade.

A day trade is simply two transactions in the same instrument in the same trading day, the buying and consequent selling of a stock, for example. The two transactions must off-set each other to meet the definition of a day trade for the PTD 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.

The Rules

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.

Leverage Advantage

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 yes, they do. Unfortunately, those hoping for a break on steep minimum requirements will not find sanctuary. Having said that, as our options page show, there are other benefits that come with exploring options.

Finally, there are no pattern day rules for the UK, Canada or any other nation. These rules are set by the US FNRA and therefore apply only in the US.

Wash-Sale Rule

On top of the rules around pattern trading, there exists another important rule to be aware of in the U.S. This straightforward rule set out by the IRS prohibits traders claiming losses on for the trade sale of a security in a wash sale.

A wash-sale is defined by trading a security at a loss, and that within thirty days either side of this sale, you buy 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 will not allow 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.

Example

For example, let’s say you bought 200 shares in Amazon for $30 each, sold the shares at $25, creating a capital loss of $1,000. Then two weeks later you bought 200 shares at $27, which you went on to sell a week later for $37 a 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 is $0.

You then add the $1,000 disallowed loss to the $5,400 cost of the shares. Your capital gain is then the $7,400 sale proceeds minus the $6,400 adjusted cost. So, you’d benefit from the $1,000 loss on the wash sale by reducing your gain on the second sale by $1,000.

Account Rules

Many traders ask do day trading rules apply to forex, stocks, options, futures, etc? But the truth is rules are usually more dependant on your broker and account. Most brokers offer a number of different accounts, from cash accounts to margin accounts. You will often find that each account comes with its own rules and regulations you’ll need to follow.

Below are several rules to investigate before signing up with a new broker:

  • Minimum deposit – Some brokers will require you to lay down considerably more capital than others when you open an account. These rules will immediately bring some brokers outside of many traders budgets. Beginners, for example, may want to look for brokers with low minimums whilst they find their feet.
  • Daily trading limit – In general, limits are used to protect against volatility and market manipulation. However, they can also be used to minimise your losses, preventing you trading too much capital. TradeStation and Scottrade may impose greater daily trading limits than Interactive Brokers and TD Ameritrade, for example.
  • Margin & leverage – Opt for a cash account and rules will prevent you from borrowing any capital from your broker. 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).

2. Timing

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. You should remember though this is a loan. A loan which you will need to pay back. Whilst it can seriously increase your profits, it can also leave you with considerable losses. Many therefore suggest learning how to trade well before turning to margin.

4. Demo Accounts

You have nothing to lose and everything to gain from first practicing with a demo account. Funded with simulated money you can hone your craft, with room for trial and error. Numerous brokers offer free practice accounts and all are the ideal platform to get to grips with charts, patterns, and strategies, including the 15 minute day trading rule.

5. Be Willing To Lose

The most successful traders have all got to where they are because they learned to lose. Losing is part of the learning process, embrace it. Having said that, learning to limit your losses is extremely important. See the rules around risk management below for more guidance.

6. Absorb Everything

Marty Schwartz famously said “A great trader is like a great athlete. You have to have natural skills, but you have to train yourself how to use them.” The best traders never get complacent. They’re always searching for that edge. That means turning to a range of resources to bolster your knowledge. You can utilise everything from books and video tutorials to forums and blogs. The markets will change, are you going to change along with them?

7. Evaluate Tips

It’s easy to get excited when an acquaintance gives you a thought-provoking tip. 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.

Application

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.

Variations

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.

Taxes

Regional Differences

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.

Key Points

Importance of following day trading rules
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. So, before you start trading, check you’re within your account rules, in line with your countries financial regulations, and meeting and any tax obligations.

Further Reading