You probably already know what day trading is. While the concept is simple, the rest isn’t necessarily a walk in the park.
Day trading is opening and closing a trade within one trading day. The idea is to potentially profit from the volatile movements that occur in the market throughout the day.
This type of trading can, of course, be very risky. It’s typically more difficult to predict short-term price movements than long-term changes …
All the more reason to educate yourself.
Ready to learn more about day trading? Here are a few tips to know before trying this strategy. Let’s get to it!
Day Trading Rules
First and foremost, you need to understand the rules and regulations for day traders in the U.S.
The Financial Industry Regulatory Authority (FINRA) has stipulations for pattern day traders — specifically regarding their account size. The rule states that pattern day traders must maintain a brokerage account balance of at least $25,000.
Sounds like a lot, right? Don’t panic. Let’s dig deeper into this rule.
What Is a Pattern Day Trader?
Knowing the rules won’t help you much if you don’t know how they apply to you.
So, what exactly is a pattern day trader?
If you make four or more day trades within a five-day period using a margin account, you can be considered a pattern day trader.
There’s a key point: The trades have to be made in a margin account. If you use a standard cash brokerage account, this doesn’t apply to you. Since trading with leverage is a risky practice, many traders avoid using margin accounts in the first place.
You can also use a simple workaround for this rule if you trade with a margin account: Hold your position overnight. Only stocks that are bought and sold within one trading day count as day trades.
However, if you do fit the criteria for a pattern day trader, then you should be aware of the pattern day trading rule …
The Pattern Day Trading Rule
So let’s say you use a margin account to make at least four day trades in a five-day period. That means the pattern day trading rule can apply to you.
In short: You need to maintain a minimum account balance of $25,000. If your account balance falls below the minimum, you can lose your buying power. Now, this doesn’t necessarily mean that you can’t make day trades … but you might have to get a little creative.
Day Trading Under $25K
It’s totally possible to day trade with a margin account with less than the required $25,000. Let’s look at a few possible workarounds.
Don’t Use Leverage
The easiest way to avoid this restriction is to not open a margin account, to begin with. Just use your cash brokerage account to make your day trades.
Using leverage is typically not recommended — it can be a perfect way to kiss your money goodbye.
What does it mean to use leverage? You borrow money to make a trade that might not work out in your favor. A bad trade can mean you lose your money and the borrowed funds.
This can be particularly risky when day trading. Daily market movements can be incredibly volatile.
Time Your Trades
How you time your trades can help you avoid the dreaded ‘pattern day trader’ label.
Remember, you have to make four day trades in five days to fit the criteria. Simple solution here: just make three.
Think about how much work goes into each trade … four trades in one week can be a lot. This can be a good way to exercise restraint and ease your trading stress.
Trade a Market Outside of the U.S.
Don’t like the U.S. rules? Another option is to trade in foreign markets with less stringent day-trading rules.
Some foreign exchange markets can allow you to day trade with a lower account balance or complete more day trades within the same five-day period.
There’s a lot to know about foreign markets. Educate yourself before you jump in to fully understand all the possible tax and legal implications of trading outside the U.S.
Hold Positions Overnight
This isn’t so much a workaround as it is a separate strategy. But if you’re edging into pattern day trader territory, you might consider holding positions overnight or longer.
Swing traders can take advantage of trends that might take days, weeks, or months to play out. This can be a great option for those who don’t meet the required day-trading account minimum but still want to be actively involved in the market.
Added bonus: Swing trading can be a little less stressful than day trading.
5 Day Trading Tips You Need to Know
Now that you better understand the rules and how they apply to you, you likely have an idea of how you can trade around them. This next step is critical: Start planning your day trading strategy.
Consider these five important tips before you start day trading.
#1 Have a Selling Plan
Before you jump into any trade, you need to establish your trading plan — and that includes your selling plan.
When will you sell? What are your expected gains? It’s crucial to answer these questions beforehand.
Day trading can be a risky strategy due to high market volatility. Things can move super fast, and if you’re not prepared, you can take a big hit.
Let’s look at a stock’s where both the opening and closing price is $3. But during the day, it moved all over the place, with a high of $4 and a low of $1.50. This isn’t exactly uncommon — particularly when dealing with low-price, high-volume stocks.
There are so many factors here that you can’t control. What you can do is research the trade, then make a plan and stick to it. That includes setting your entry and exit points. You may not always hit them perfectly, but it’s a good goal to set.
And it’s better to have small gains than losing the entire trade.
#2 Keep a Day Trading Journal
Not into journaling? Get over it. If you want to make the most out of your trades, you need to keep and update a day trading journal.
First, it’s an easy way to track your trades, gains, and losses.
More importantly, you can use this data to analyze your overall market performance. You can track how well you tend to stick to your strategy. Even better, you can use it to tweak your strategy — do more of what’s working and scrap what isn’t.
It’s not just about the data, either. It’s how your mind and emotions can play into your trades.
A day trading journal can be a window into your assets and flaws. Use your journal knowledge to help you stop the cycle of making the same mistakes over … and over … and over.
#3 Cut Your Losses
It’s the number-one rule in trading: Cut your losses.
Once you start to lose money on a position, don’t wait around to see if it rebounds. Sure, it might, but it’s also just as likely to continue to drop. Get out early.
You should place your stop strategically to minimize losses while leaving enough room for normal price fluctuations.
All it takes is one bad trade to completely negate any profits you may have made. Losing a little money sucks, but losing everything is much worse. Cut your losses as quickly as possible.
#4 Focus on the 80/20 Rule
The 80/20 rule is more of a general concept, even though it’s called a ‘rule.’ As it relates to trading, this rule suggests that 80% of your profits will be generated by 20% of your trades.
This rule is important as it underlines an important fact — not all of your trades will be successful. Probably not even most of them.
That doesn’t necessarily mean that 80% of your trades will result in a loss. It just means that you shouldn’t expect to reap significant profits from every trade you make.
Need to take a break? That’s OK. There’s nothing wrong having a relatively stagnant account for a while. Maybe you’re just not spotting trades that fit your style or strategy. It happens. That can mean more opportunity for plenty of market research.
It’s also a chance to try new strategies with paper trading.
#5 Be Patient
Day trading takes time to learn. No one jumps into day trading and becomes a millionaire overnight. No one.
It takes time to develop strategies, and odds are that your strategies will change with the markets and over time. The important thing is that you remain patient and stick to your trading plan.
Plan your buys, sell while you’re ahead, and cut your losses quickly. Keep those key tips in mind and be willing to stick with it for the long-term.
These five key day trading tips are essential when you’re working to develop your own strategy.
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The Bottom Line
Day trading is a common strategy, but just because it’s common doesn’t mean it’s easy. This can be a very difficult strategy to master. Volatile market movements can make it tough to execute flawless trades within a single trading day.
That doesn’t have to scare you — although you do need to be aware of the risks. Day trading isn’t necessarily a bad idea …
It all depends on you, your trading strategy, your research, and your trading education. Use the tips in this post to understand the pattern day trading rule and if it applies to you. Once you know the rules, you can learn how to navigate day trading.
What trading rule do you stick to no matter what? How does it help you in the markets? Please share … we love to hear from you!