Day trading: the rules and basics of daily speculation

 Day trading: the rules and basics of daily speculation

If you are interested in day trading, you are not alone. There is no shortage of people who claim to know the secret to beating the market with day trading. However, the reality is more complex. Day trading comes with some higher risks, and is more strictly regulated than other types of investment. Learn now the rules of day trading and how it works with our guide.

This guide will give you answers to some of the most important questions about day trading:

What is day trading and how does it work?

Is stock trading profitable?

What is the difference between trading and investing?

Day trading is the buying and selling of the same stock within a day using a margin account. Unlike a cash brokerage account, which is funded only with your money, a margin account allows you to take loans from your brokerage. This is called "trading on margin" or "leverage".

In theory, leverage multiplies your resources so you can buy and sell more shares, potentially making a bigger profit. Of course, you will have to repay the loan, plus interest and fees.

But leverage also multiplies any losses you may incur. You can lose your own money and end up in debt to the broker as well.

How day trading works

Day traders look for securities with prices that bounce up and down each day. They then bet on whether the value will go up or down during the afternoon, or even over the course of a few minutes. Based on these bets, traders buy and sell shares on the same day.

Ideally, the trader would guess correctly and make many small profits accruing. However, predicting price changes is very difficult, even with high-tech software. Margin trading magnifies the risk, because any loss multiplies quickly.

Since trading is highly risky, people who day trade regularly must follow special trading rules.

day trading pattern

Regular traders today are called pattern traders. If your brokerage firm determines that you are a typical day trader, you will be subject to the trading rules.

Generally, you will be marked as a typical trader if your trading activity matches the following:

You make four or more trades in one day

You make daily deals within five business days

The number of daily trades is more than 6% of the total trades in your margin account for the same 5 business days.

Brokerages are required to designate you as a pattern trader if they have a reasonable belief that you are participating in the pattern of trading, even if you do not exactly match the above criteria. For example, some brokerages offer lessons on trading. If you take one, you may be flagged before even one trade is made.

Some rules of day trading

Once you are marked as a trader, you will face special restrictions.

Rule 1: Minimum Equity Requirement

Day pattern traders are required to hold a minimum of $25,000 in cash or securities in their margin accounts when trading. The account must meet minimums at the beginning of the trading day and remain committed throughout the day.

If the account drops below $25,000, the broker must suspend day trading until the minimum capital requirements are met. Some brokerages have higher minimums.

Rule 2: Buying power of trading

On any given day, a day trader's buying power is limited to the previous day's account balance. According to the trading rules, the trader cannot exceed four times the excess maintenance margin at the close of the previous day. Brokerages can set stricter limits.

If you exceed the limit, the brokerage must issue a margin call. Which is a notice that you have five business days to bring your account into compliance. Meanwhile, your purchasing power will decline. If you do not respond to the call in time, you cannot trade on margin for 90 days or until the call is met.

Again, brokerage firms can have stricter rules about margin calls. For example, they usually only allow trading after you comply with it. They may also sell the securities in your account, without prior notice, to fulfill the call.

Day trading of stocks

Ultimately, you'll have to make the decision yourself, but here's what the experts at the Securities and Exchange Commission (SEC) have to say:

“Trading is very risky and can lead to huge financial losses in a very short period of time. ”

The Financial Industry Regulatory Authority (FINRA), which is responsible for supervising brokerage firms to protect US investors, agrees and sets trading style rules as follows:

“Trading on a daily basis can be very risky. Trading in general is not suitable for someone with limited resources, limited investment or trading experience and a low tolerance for risk. So the investor should be prepared to lose all the money he uses in trading.”

There is science to support these statements, as one study on the success rate of day traders found that 97% of day traders lost money over the long term, and only 1% earned more than minimum wage.

Every investment involves risks, including the risk of losing money. Many experts agree that trading is one of the riskiest options. So, if you are considering whether you should buy and sell stocks on the same day, be aware of the risk before it goes down.

The difference between investing and trading

Trading can be exciting for some, as many proponents admire the quick money-making potential this investment activity offers. But just like any get-rich-quick scheme, trading can result in financial loss and potentially get you into debt, even if you follow the rules of trading to the letter. Fortunately, there is a much safer way to invest through buy and hold. With a long-term investment strategy, you may have a much better chance at a brighter financial future.

Traders seek quick profits by entering and exiting the market in moments. Many experts suggest that a less risky strategy is to take a bigger picture by buying and holding securities for the long term, and out of the inevitable market ups and downs.

Diversifying your portfolio among stocks, bonds, funds and various market sectors can also reduce risk. Knowing your risk tolerance level can help you make investment choices that align with your long-term goals.

Disclaimer: The content of this article is for informational purposes only. The information provided should absolutely not be considered as an investment advice or recommendation. There is no express or implied warranty as to the accuracy of the information or data contained herein. Users of this article agree that Money Secrets does not accept responsibility for any of their investment decisions. Not every investment or trading strategy is suitable for anyone. See the risk warning statement.

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