Question

What is the 6% day trader rule and an example of it in a real life scenario?

Answer 1

Under the FINRA rules, a pattern day trader must maintain a minimum equity of $25,000 on any day that the customer day trades. The required minimum equity must be in the account prior to any day-trading activities.

So, that would suggest that, yes, you do need $25,000 to partake in “day trading activities.” But that’s only if you fit the definition of a day trader, which is very simple.

  

A pattern day trader is a stock market trader who executes four or more day trades in five business days in a margin account.

Notice that last part: “in a margin account.”

As for the $25,000 figure, the confusion comes from the U.S. regulators who instituted the much maligned “Pattern Day Trader Rule.”

Understand first that brokers want you trading all of the time because they make money on commissions, and in order to trade all the time freely, you need $25,000. But if you truly want to get wealthy, you shouldn’t be listening to what your broker says.

You should listen to what actually works, as proven by my top Trading Challenge students and I.

Day Trading Rules and Requirements

Let’s revisit my definition of a pattern day trader: “A pattern day trader is a stock market trader who executes four or more day trades in five business days in a margin account.”

This means that you need to execute at least four day trades in five consecutive days using a margin account. That sentence actually includes a lot of limitations.

First, a day trade occurs when you buy and sell shares in a stock between market open and close. If you hold your position overnight, the transaction is no longer considered a day trade.

I will repeat this because some people have problems believing it: The Pattern Day Trader Rule does NOT limit you from making more than three trades per week. You can hold a stock or even two or three stocks overnight, every single night, but you are limited on your intraday trading to just three intraday trades per week.

Given your small account size and likely lack of experience (hence the small account size), this is a good thing. It makes sure that you don’t churn and burn your account to ashes like too many newbies do, trying to catch every single stock and every single move up and down all over the place.

Second, you have to make at least four trades per week.That’s actually a lot of trades. I encourage my students to exercise restraint.

Many traders want larger accounts. In addition to being compliant with the pattern day trader rule, you can get more leverage if you have over $25,000 in your brokerage account.

Some brokers offer 4:1 or even 6:1, which means that, if you have just $1,000, you can now gamble with $4,000 or even $6,000.

Make no mistake — I use the word “gamble” on purpose because my top Trading Challengestudents and I do not gamble and do not use leverage. It’s very easy to lose huge chunks of money when you’re gambling with leverage because it doesn’t feel like “your money.”

So, yes, my top students and I are perfectly happy to make three or less — not four or more — day trades per week to fit comfortably under the pattern day trader rule.

And finally, the pattern day trader rule only applies if you’re using a margin account. If you’re using a regular cash brokerage account, you don’t need to worry about the rule.

I urge my students to avoid leverage at all costs, which means you don’t need a margin account. You can use my recommended brokers to open a cash account with as little as $500 and begin trading.

Day Trade Limit: Minimum Equity of $25,000

Let’s say that you’ve opened a margin account and you intend to make four or more intraday trades in a week. I caution you against it, but many traders ignore my advice.

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In this case, you’ll need to maintain minimum equity of $25,000 in your account to remain compliant with the pattern day trader rule. Some brokers jump the gun and make assumptions based on your answers to their questionnaires or your trading activity. They’ll let you know that you have to add money to your account.

Day Trading Rules Under $25K

If you have a cash or margin account with less than $25,000 in it, you can still day trade. You just have to exploit the loopholes in the pattern day trader rule.

As I’ve already noted, you can day trade in a cash account, which means that you’re not using leverage and your activity doesn’t fall under the pattern day trader rule. I like this option because it keeps you focused on making smart, manageable plays.

You can also trade in foreign markets that have less stringent requirements. If you’re interested in FOREX or in foreign stock exchanges, you might be able to day trade more frequently with less money.

Pattern Day Trader Example

There are several situations in which the pattern day trader rule might apply.

Let’s say you open a margin account with a broker and deposit $10,000. On the first day, a Monday, you buy and sell leveraged shares of stock XYZ. On Tuesday, you buy and sell stock ABC, and on Wednesday, you short-sell stock DEF. Thursday comes around and you buy and sell shares of both ABC and XYZ. That’s five trades in four days, which means that you’ve met the criteria for the pattern day trader rule.

In this scenario, maybe you have equity of $15,000 in your brokerage account. You would have to deposit another $10,000 to abide by the FINRA guidelines.

My Tips on Following the Pattern Day Trader Rule

At one point, I hated the pattern day trader rule. It meant that I was limited in what I could do with my own money. Over time, though, I’ve embraced it and found ways to work around it.

I know it’s tough to watch the market day in and day out and not trade, so I encourage everyone with itchy fingers to practice, practice, practice. Use the new paper-trading feature on this must-have software and try not to take too much away from your “paper profits” because it’s far easier when it’s not real money and there’s no emotion attached to the trade.

It’s the emotional discipline that most people lack that causes 90+ percent of traders to lose.

I know I’m throwing a lot of facts and concepts at you, so let me make it real simple:

You don’t need to trade as much as you think you do to get rich.

If you do trade as much as you think you need to, you will never be rich.

Got it?

Let’s look at some of my best tips to avoid falling prey to the pattern day trader rule.

Don’t Use Leverage

I know I’ve already brought this up, but it bears repeating. Using leverage is a great way to lose your money. Why? Because you’re using someone else’s money on a play that might not work out.

If you don’t open a margin account at all, you don’t have to worry about the pattern day trader rule. Instead, use your cash account to make all your trades.

Don’t Make More Than Three Day Trades a Week (Especially When You’re a Newbie)

This is a good rule of thumb regardless of whether or not you have a margin account. Buying shares of every stock that looks interesting will result in uncontrollable churn. It’s more difficult to keep your eye on multiple trades at once, and if you’re getting in and out in a short period of time, you need to be able to concentrate.

Focus on The 80-20 Rule

The 80/20 rule on brown envelope created by chattanongzen – Shutterstock.com

You’ve probably heard of this rule before. It applies to a lot of things, but in the stock market, it means that about 80 percent of your income will come from 20 percent of your trades.

Does that scare you? It should. If you’re executing trades left and right, the 80-20 rule can start to work against you. The remaining 80 percent of your trades are likely to result in losses that your 20 percent can’t cover.

Set Strict Goals

Goals are a cornerstone of successful stock trading. If you don’t have goals, you won’t have anything to work toward.

What do you want to accomplish through day trading? Maybe you need a new car, or perhaps you want to secure your retirement.

Whatever the case, visualize your goal as you make trades. Before you pull the trigger, ask yourself, “Am I willing to put my goal on the line for this trade?” If the answer is no, stop and reassess your trade.

Be Prepared for the Stock Market

I can’t emphasize enough the importance of research, education, and preparation. If you’re unfamiliar with the stock market, start by learning everything you can.

This blog provides an awesome resource to get you started. I’ve written thousands of articles on penny stocks, day trading, and more. Spend every spare moment reading everything you can.

Trading Challenge

I also suggest signing up for my Trading Challenge. It’s one of the best ways to harness your motivation and learn from me as well as my most successful students.

You’ll know what trades I make every day and the reasoning behind them. Plus, you’ll have access to thousands of dollars worth of premium resources.

Is Day Trading Illegal?

There’s nothing illegal about day trading. As I mentioned earlier, day trading simply refers to the practice of making trades between market open and close. That’s it.

Where you might run afoul of day trading rules is with the pattern day trader rule. Make sure you’re not using a margin account to make four or more trades per week with less than $25,000 equity in your account.

Day Trading Laws

Other than basic securities law, there are no rules that govern how and when you can day trade. If you’re using a cash account, feel free to execute 20 trades per day. I don’t recommend it, but you have that right