This is one of the most wrongly interpreted trading terms out there. Although there is a pattern day trader rule, it will probably not apply to most traders out there, and is much more complicated than many realize. It can be advantageous those day traders and penny stockers that do not trade on margin. But in order to be able to advantage from it, you must first understand what it is.
A trader must, under the rules of FINRA, maintain a level of equity of a minimum of $25,000 on any given day where they trade. This has to be deposited into their account before they can begin day trading. However, this rule only applies if you are a day trader, and fit the definition of one.
A day trader is defined as an individual that executes at least four day trades within any five consecutive days from a margin account.
Rules and requirements for day trading
As previously stated, in order to be classed as a day trader you must make a minimum of four trades over a minimum of five days. A trade is only considered a day trade when you sell or buy stocks between the market opening and the market closing. Where a position is held overnight, this is not considered as a day trade.You are not limited from making multiple trades each week. You can hold as many stocks as you want overnight, every night, but there is a limit on the amount of intraday trades that you are allowed to make each week. This limit is three trades. This is actually a good thing for those traders with little experience and small sized accounts. It stops you from losing large amounts of money, like many who are new to trading do.
Making a minimum of four trades each week is actually a large amount. Many experienced traders demonstrate great restraint and execute trades only as and when necessary.
The $25,000 day trade limit
Imagine you have opened a margin account and you want to make at least four trades each day within a single week. To do so you must have a minimum equity level of $25,000 sitting in your account to be within the rule.Under the $25,000 day trade limit
For those traders that have less than $25,000 in their margin account, or even a cash account, they can still do day trades. It is just a case of working through the loopholes in the Pattern Day Trader rule.By trading with a cash account you do not use any leverage from a brokerage firm and so any activity on your account does not fall under the rule. Trading this way keeps you more focused on making plays that are both smart and manageable.
It is also possible for you to trade in foreign markets where there are less strict requirements. If you trade in FOREX you are able to day trade not only more frequently but with less money.
How to follow the Pattern Day Trader rule
Despite the limitations imposed by this rule, there are some ways to work around it. Those more impatient traders should do lots of practice, including watching the markets continually each day without actually trading. The key thing to understand here is that you do not need to trade as much as you think you need to. Overtrading is a surefire way to never get rich.Some of the best ways to avoid hitting the restrictions of the rule include:
- Setting strict rules – This is the absolute cornerstone of any successful trade(s). Without set goals you do not have anything to aim for and work towards. You should establish what you want to achieve from day trading, such as funding the purchase of a new car or a retirement pot. Whatever it is you should visualize it before making any of your trades and ask yourself if it is worth the risk of potentially losing it.
- Focusing on the 80-20 rule – You should focus on making 20 percent of all the trades you make account for 80 percent of your total income. This focuses you on making the best trades and stops you from rushing into things and making rash decisions.
- Not using leverage – Using leverage by the means or a margin account is pretty much a guaranteed way to lose money. This is because you are lending money off of a brokerage firm to make a trade that might not come off. Not opening a margin account can mitigate against this happening. You should always use your own cash to make your trades.
- Being prepared – Making sure you do lots of preparation in the form of education and research are vitally important. If you are new to trading then you need to start learning as much as you can, as quickly as possible. There are lots of resources out there to get your started.
- Not making over three trades each week – This is something that should be stuck to no matter what kind of account you are trading with. Buying too many stocks from a variety of different companies will result in a highly uncontrollable churn. It is very difficult to keep focused on multiple trades all at once. If you plan on getting in an out of your position quickly then you need to be able to focus.
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