No one likes too many rules, but as we have always been told they are there for your own benefit. Trading is no exception to the rule. If you want to stay in the game and not fall into the red, from stocks to cryptocurrency there are some key rules you need to follow.
Whether you are a beginner or a seasoned trader below we will go over some of the most useful rules to follow. There may be variables depending on where you are in the world, but some, like risk management, apply to all.
Margin requirements for pattern day traders in the USA.
If you are living in the United States and fit under the label of pattern day trader with a margin account trading above or below 25k then there are some important rules for you courtesy of the Financial Industry Regulation Authority (FINRA).
What makes you a Pattern Day Trader?
To meet the minimum criteria you must trade at least three out of five business days with a minimum of 6% in your account for the duration.
What is a Day Trade?
It all comes down to the number of trades executed on the same day. A day trade by definition is the execution of two trades, that off-set each other, carried out on the same day. Buying stock and selling the stock for example, just be sure not to hold a position overnight.
Number Of Trades
The total quantity of shares can become confusing to individuals and cause expensive mistakes.
If you go into a stock position with a lone order of 2000 shares and leave the position with two orders of 1000 all three transactions will be grouped together and will count as one day trade.
On the contrary, if you go into a trade with two separate 1000 trade orders and open a new position when closing it if you close it with only one order of 2000 trades this will also count as a one-day trade
Imagine you open with two 400 trade orders and close with the same two trade orders, this would be considered two-day trades with two transactions at both ends.
So now we know what constitutes a pattern trader, let’s get down to the rules that you must comply with.
Money money money– You must sustain an account balance of 25,000. Without that amount, you will not have enough buying power. You can meet the requirement combining eligible cash with securities but you cannot meet it by cross-guaranteeing two different accounts.
The condition of existing sales-if you repurchase an existing position from the previous day it is not considered to be a day trade.
Buying power- The power to buy- by the end of a business day your power to trade will be four times the New York Stock Exchange than the day before. You may not exceed the limit if you do so a margin called will be issued.
When a margin call is outstanding- The aggregate method, calculating the total number of day trades will be used when an account has an outstanding margin call, not the ‘time and tick’ technique.
You must meet margin calls- once a margin called has been issued you have five business days to provide more funds, if not your buying power will be reduced and you will be left with only one time the New York Stock Exchange.
Keep the funds in the same place- to meet the requirements for margin calls you cannot move your funds for two days immediately after making a deposit.
More to play with-If you hold a pattern day trading account you may hold higher positions, including those worth twice your account balance, and twice the standard margin with stocks. Potentially this could substantially increase your profits. Don’t get too excited however, there is a risk. You must be able to subsidize your investment if not you may have your position liquidated by your broker.
Start as you mean to go on-like many things in life the first label you assigned is the one that sticks. Your broker, once done training you as a beginner day trader may label you as one if you cannot come up with significant amounts of money from the offset.
Do the rules apply to cash accounts?
In general, if you are holding a non-margin cash account you cannot trade. You could even be violating the free-ride prohibition if you fail to pay for an asset in a cash account in which case the broker will enforce a ninety-day freeze on your account.
But do the rules apply to options?
Pattern day trading rules do indeed apply to options. If you want to know more about the benefits of exploring options check out the options page. The pattern day rules however only apply to the US where the FNRA has ruling power.
In the US it is important to be aware of the wash-sale rule in order to avoid having problems with the iRS. Thanks to the IRS this rule means that a trader cannot claim losses on a trade sale carried out in a wash sale.
A wash-sale is defined by trading 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. If you sell a security but then your spouse or your company go ahead and buy a similar security the same rules apply.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 which then becomes the cost basis for the new stock.
What is it?
Simply if you were to sell your shares at a loss but then re-buy them within thirty days then this would count as a wash-sale.
For example :
You buy 200 hundred shares on Twitter each share with the value of $30 if you go onto sell these shares at a $5 your capital loss would be $1000. If a week later you bought 200 of the same shares back at $27 a share and then proceeded to sell them at a profit for say $37 your net loss on the wash sale would be $5000 on the original sale, minus $6000 plus the $1000 adjustment which would come out to be $0. If you add the $1000 disallowed loss to the cost of the shares which was $5,400 your capital gain would be $7,400 from the sale proceeds take away $6,4000 from the difference in cost. You would end up gaining $1000 from the loss on the wash sale.
Broker account rules
Your broker is the one controlling your accounts and they usually have their own rules and regulations depending on the type of account you hold whether that be a margin account or cash account.
Broker Rules-Before signing up with a Broker check out their rules, below are some to be aware of.
Deposits– All brokers will require a minimum deposit but how much that deposit depends on the broker, beginners may have to look for brokers with the smallest minimum to start with
Trading limits per day- Limits are put in place to control against the volatility of the market and potential manipulation, some may even place limits to control your losses
Margin versus cash account- If you go for a margin account you most likely will be able to borrow a certain amount from your broker giving you more leverage. A cash account however will not permit you to borrow anything from your broker.
Refer to our broker’s page for more information.
7 Golden Rules For Beginners
Follow these rules and you will be well on your way to making good profits and avoiding expensive mistakes.
- Game Plan– every smart player has a game plan, they know when to enter but also when to walk away. ‘A goal without a plan is just a wish’ said Antoine de Saint-Exupéry . Plan your moves carefully, applying the risk-management rules nad stop losses will help maintain profits not losses ( see below).
- Timing is everything-The excitement when the market opens can cause panic trades and there will be market orders from the night before. Patience will be your best friend here, wait for the first fifteen b=minutes and take that time to observe and to watch out for any reversals.
- Be cautious about using the Margin-take your time and get to know how to trade before turning to the margin. Although it can be tempting and could seriously increase your profits the same can be said for your losses. After all, it is a loan and this should not be forgotten.
- .Practice makes perfect-take advantage of free practice accounts if your broker offers them. With nothing to lose using a market, a simulator is the best way to perfect your craft without losing money. Here you can get a handle on your strategies, patterns, and charts.
- Be a good loser– to get anywhere int he games you are going to have to get some losses under your belt. It is time to be a graceful loser but within reason.
Use your recourses Marty Schwartz famously said “A great trader is like a great athlete. You have to have natural skills, but you have to train yourself on how to use them.” There is so much information out there, on the web, in books, podcasts, youtube, blogs and coaches take advantage of the information out there and educate yourself.
Check your sources-Don’t take everything you hear as gospel, Jesse Livermore the trader 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 judgment.” A wheel meant peace of advice can land you in problems, so check your sources and think before the following advice. Or refer to this tips page.
Rules for Risk management
Following these rules could determine how successful you are as a trader.
The 1% Risk Rule
What is the 1% risk rule– the concept is that you should aim not to lose more than 1% of your capital on any single trade. Following this rule will enable you to never lose more than you can afford.
Why should I apply this rule?
Well nobody wants to lose all their money, and this is a surefire way to ensure that there is always money in your account whilst still being able to turn profits.
You might worry that you cannot make sufficient money trading such small percentages, but this is not the case. If you trade 1% you can expect to profit 1.5%-2% which will start adding up.
This is the safest and most intelligent system for beginners. You can lose safely and keep practicing until you master your skills.
How to apply the 1% rule
It’s time to implement your stop-loss orders and use your targets. Imagine you want to buy stocks valued at $20 apiece, with $40,000 in your account, if you see that the most recent swing0low brought it down to $19.90 place your stop loss 1% lower at 19.89. Now it’s time to work out how much you can trade without losing more than 1% which in this example is $400. Your trade risk then is $0.11 which is now the difference between your stop loss and the entry price.
The next step is to divide your account risk by your trade risk which will give you your position size.
Account risk-$400 / $0.11 = 3,636 shares.
Now you know what you can safely trade without going over your 1%.
Increasing or decreasing the 1%
Once you have become a veteran trader you could choose to increase the percentage. Similarly, if you have over $100,000 in your account you may want to drop the 1% even lower as you could still end up losing a substantial amount.
It’s important to find what works for you in regards to your income.
Taxes- everyone’s favorite topic and unfortunately inescapable. It doesn’t seem to matter how far you travel what you pay in taxes will largely depend on where you are and what you are trading. The taxes you have to pay as a day trader will vary depending on whether you are paying the IRS or the HMRC for example.
It is very important to find out what type of tax you will pay, be it personal income, business, or capital gains and will you be paying that at home or abroad?
There may be situations that give you more leeway than others, individual retirement accounts for example so make sure you do your research or check out this taxes page.
Trading is not just about the thrill and excitement of watching your stocks increase. It requires a lot of research and forwards planning. There are so many variables, not exclusive to where, when, and with which broker you are trading from. There are rules in place to help you become the best that you can be, Play safe in the beginning and this can set you up to earn handsome profits. Research your tax obligations and inform yourself about every element of intraday trading.