Day Trading Rules For Stocks - Futures - Emini Contracts
Are you an Active Day Trader? If so, there are 2 sets of day trading rules you must be aware of. One set of rules are issued by regulatory agencies such as the SEC / FINRA / NFTA / IRS. The second set of rules are ones you establish as the foundation of your day trading business. The first set are actual laws you as a Day Trader must abide by to avoid fines, penalties or criminal charges.
Most traders find it easier to follow rules dictated by others, even when they seem arbitrary or unfair. It's not simply the fear of prosecution, it's a conditioned response we carry with us from birth. From an early age we are told what to do and when to do it. As we grow older we begin to yearn for independence, fueled by a desire to make our own decisions. Let's address the "easy" list first.
Regulatory Agency Day Trading Rules and Guidelines
What is a Day Trade?
- The Financial Industry Regulatory Agency (FINRA) defines a "Day Trade" as purchasing and selling or the selling and purchasing of the same security on the same day in a margin account. This definition encompasses any security, including options. Also, the selling short and purchasing to cover of the same security on the same day is considered a day trade.
Exceptions to this trading rule include:
- a long security position held overnight and sold the next day prior to any new purchase of the same security; or a short security position held overnight and purchased the next day prior to any new sale of the same security.
Who is a Pattern Day Trader?
A pattern day trader is defined in Exchange Rule 431 (Margin Requirement) as any customer who executes 4 or more round-trip day trades within any 5 successive business days. If, however, the number of day-trades is less than or equal to 6% of the total number of trades that trader has made for that five business day period, the trader will not be considered a pattern day trader and they will not be required to meet the criteria for a pattern day trader.
A non-pattern day trader (i.e. someone with only occasional day trading), can become designated a pattern day trader anytime if they meet the above criteria.
If the brokerage firm knows, or reasonably believes a client who seeks to open or resume an account will engage in pattern day trading, then the customer must immediately be considered a pattern day trader without waiting 5 business days.
Day Trading Minimum Equity Requirement
What is the minimum equity requirement for a pattern day trader?
- The minimum equity requirements on any day in which you trade is $25,000. The required $25,000 must be deposited in the account prior to any day-trading activities and must be maintained at all times.
Why is the minimum equity requirement for pattern day traders higher than the current minimum equity requirement of $2,000?
- The minimum equity requirement of $2,000 was established in 1974, before the technology existed to allow for electronic day trading by the retail investor. As a result, the $2,000 minimum equity requirement was not created to apply to day-trading activities Rather, the $2,000 minimum equity requirement was developed for the buy-and-hold investor who retained securities collateral in his/her account, where the securities collateral was (and still is) subject to a 25 percent regulatory maintenance margin requirement for long equity securities.
Do these day trading rules apply to Options?
- Yes. Pattern day trade rules and margin requirements apply to Equities, Options, Bonds and Electronically Trade Funds (ETF).
Internal Revenue Service (IRS) Guidelines
Special rules apply if you are a trader in securities, in the business of buying and selling securities for your own account. This is considered a business, even though you do not maintain an inventory and do not have clients. To be engaged in business as a trader in securities, you must meet all of the following conditions:
- You must seek to profit from daily market movements in the prices of securities and not from dividends, interest, or capital appreciation.
- Your activity must be substantial, and
- You must carry on the activity with continuity and regularity.
The following facts and circumstances should be considered in determining if your activity is a securities trading business:
- Typical holding periods for securities bought and sold.
- The frequency and dollar amount of your trades during the year.
- The extent to which you pursue the activity to produce income for a livelihood, and
- The amount of time you devote to the activity.
If the nature of your trading activities does not qualify as a business, you are considered an investor, and not a trader. It does not matter whether you call yourself a trader or a “day trader,” you are an investor. As with dealers, a taxpayer may be a trader in some securities and may hold other securities for investment. The special rules for traders do not apply to the securities held for investment. A trader must keep detailed records to distinguish the securities held for investment from the securities in the trading business. The securities held for investment must be identified as such in the trader's records on the day he or she acquires them (for example, by holding them in a separate brokerage account).
Traders report their business expenses on Form 1040, Schedule C (PDF), Profit or Loss From Business. The Schedule A limitations on investment interest expense, which applies to investors, does not apply to interest paid or incurred in a trading business. Commissions and other costs of acquiring or disposing of securities are not deductible but must be used to figure gain or loss upon disposition of the securities. See Topic 703, Basis of Assets. Dividends, interest from securities, and gain or loss from the sale of capital assets are not considered proceeds from self-employment income unless received by a dealer in stocks and securities in the course of their business. Review the Form 1040, Schedule SE Instructions, Self-Employment Tax. Source:IRS.Gov
Personal Rules For Trading Stocks Futures And Options
This is the difficult list. This is the list no one will attempt to enforce. You are about to realize just how alone you really are. When temptation comes knocking, your only defense is self-discipline. Most commodities can be bought and sold on the open market. Self discipline is far too rare. You can't buy it, rent it, borrow it, you can't even steal it. It comes from within. It is the very thing that creates the statistics our friends and family throw in our face.
How is it that even your gardener knows 90% of Daytraders fail within the first year? Probably because he tried it and was smart enough to spend his last $200 on a weed whacker and hedge clippers. Self-discipline comes from within and for most of us, it doesn't come easy. If watching all the Karate Kid movies doesn't do the trick, welcome to the real world.
Your strategy, the one you've festered over for the last year(s), is probably the least important factor in building a successful trading business. The one thing that will move you out of the 90% and into the 10, is your ability to think, make decisions and act, void of emotion. You will need nerves of steel and a cast iron stomach, but most of all.. you need discipline.
Dennis Gartman is famous for many things, one thing is his Rule of 22. We neither endorse nor follow all of these rules, but some of them do make good sense.
- Never, under any circumstance add to a losing position.... ever! Nothing more need be said; to do otherwise will eventually and absolutely lead to ruin!
- Trade like a mercenary guerrilla. We must fight on the winning side and be willing to change sides readily when one side has gained the upper hand.
- Capital comes in two varieties: Mental and that which is in your pocket or account. Of the two types of capital, the mental is the more important and expensive of the two. Holding to losing positions costs measurable sums of actual capital, but it costs immeasurable sums of mental capital.
- The objective is not to buy low and sell high, but to buy high and to sell higher. We can never know what price is "low." Nor can we know what price is "high." Always remember that sugar once fell from $1.25/lb to 2 cent/lb and seemed "cheap" many times along the way.
- In bull markets we can only be long or neutral, and in bear markets we can only be short or neutral. That may seem self-evident; it is not, and it is a lesson learned too late by far too many.
- "Markets can remain illogical longer than you or I can remain solvent," according to our good friend, Dr. A. Gary Shilling. Illogic often reigns and markets are enormously inefficient despite what the academics believe.
- Sell markets that show the greatest weakness, and buy those that show the greatest strength. Metaphorically, when bearish, throw your rocks into the wettest paper sack, for they break most readily. In bull markets, we need to ride upon the strongest winds... they shall carry us higher than shall lesser ones.
- Try to trade the first day of a gap, for gaps usually indicate violent new action. We have come to respect "gaps" in our nearly thirty years of watching markets; when they happen (especially in stocks) they are usually very important.
- Trading runs in cycles: some good; most bad. Trade large and aggressively when trading well; trade small and modestly when trading poorly. In"good times," even errors are profitable; in "bad times" even the most well researched trades go awry. This is the nature of trading; accept it.
- To trade successfully, think like a fundamentalist; trade like a technician. It is imperative that we understand the fundamentals driving a trade, but also that we understand the market's technicals. When we do, then, and only then, can we or should we, trade.
- Respect "outside reversals" after extended bull or bear runs. Reversal days on the charts signal the final exhaustion of the bullish or bearish forces that drove the market previously. Respect them, and respect even more "weekly" and "monthly," reversals.
- Keep your technical systems simple. Complicated systems breed confusion; simplicity breeds elegance.
- Respect and embrace the very normal 50-62% retracements that take prices back to major trends. If a trade is missed, wait patiently for the market to retrace. Far more often than not, retracements happen... just as we are about to give up hope that they shall not.
- An understanding of mass psychology is often more important than an understanding of economics. Markets are driven by human beings making human errors and also making super-human insights.
- Establish initial positions on strength in bull markets and on weakness in bear markets. The first "addition" should also be added on strength as the market shows the trend to be working. Henceforth, subsequent additions are to be added on retracements.
- Bear markets are more violent than are bull markets and so also are their retracements.
- Be patient with winning trades; be enormously impatient with losing trades. Remember it is quite possible to make large sums trading/investing if we are "right" only 30% of the time, as long as our losses are small and our profits are large.
- The market is the sum total of the wisdom ... and the ignorance...of all of those who deal in it; and we dare not argue with the market's wisdom. If we learn nothing more than this we've learned much indeed.
- Do more of that which is working and less of that which is not: If a market is strong, buy more; if a market is weak, sell more. New highs are to be bought; new lows sold.
- The hard trade is the right trade: If it is easy to sell, don't; and if it is easy to buy, don't. Do the trade that is hard to do and that which the crowd finds objectionable. Peter Steidelmeyer taught us this twenty five years ago and it holds truer now than then.
- There is never one cockroach! This is the "winning" new rule submitted by our friend, Tom Powell.
- All rules are meant to be broken: The trick is knowing when... and how infrequently this rule may be invoked!
There you have it. Rules to keep you out of trouble and rules to keep you solvent. The first list of Day Trading Rules is the law so there really is no discussion there. Like it or not, you just have to do it. The second list is obviously somewhat subjective and one man's opinion.
If you plan to become a day trader, I mean really become a day trader, you have to make your own rules. To make your own rules, you will need enough information to make intelligent decisions. Fortunately, information is something you can buy. Shop around. When you're done... give us a call.