How Much Money do You Need to Start Day Trading
Most investors who decide to become day traders are ready to take on the stock market aggressively. However, some may wonder how to get started with day trading and what logistical aspects are involved. For example, an important question is, “How much money do you need to start day trading?” There are some misconceptions about what is required by law and how much a brokerage firm may require. Here’s what you need to know on how to get started day trading.
Minimum Equity Requirement by Law
On February 27, 2001, the Securities and Exchange Commission (SEC) approved a new set of day trading margin rules. The regulation defined “pattern day traders” as a stock trading customer that engages in day trades at least four times within five business days.
It is worth noting that a brokerage firm also can designate you as a pattern day trader. If they have a reasonable basis for categorizing you as a pattern day trader, such as if the same firm provided you day trading training as well as your account, the minimum equity requirement might also apply to you. Understanding the trading system and the different strategies is crucial.
These pattern day traders are now required to maintain a minimum equity requirement of $25,000 in his account balance at all times. If the account falls below the minimum, the trader’s account would be suspended until the trader replenished the funds to reach the legal minimum threshold.
In 1974, the minimum equity requirement was $2,000. However, with the introduction of electronic trading, the risks of day trading increased dramatically. As a result, the purpose of this minimum equity rule is to produce enough funds to support the risks associated with intraday trading.
Of course, the minimum equity requirement only applies to U.S. stock markets. In other words, U.S. futures and currency markets do not yet have a pre-determined financial minimum, except what is dictated by your brokerage firm.
As a result, if your trading habits are frequent enough to categorize you as a pattern day trader, the minimum amount to start day trading is $25,000. However, your account must also provide excess funds as a buffer for trading flexibility to absorb losses. Remember, even the best traders lose 30% to 40% of their trades. More importantly, successful traders have a trading strategy and can retrace their losses with significant gains from profitable trades.
Capital Requirements for Risk Management
In general, risk management helps reduce losses. It is a rule-based system that helps protect a trader’s financial account from losing all of his or her funds. While a trader may make substantial profits, he can also squander it all in in one or two bad trades without a strict risk management strategy.
A day trader may suffer a series of losses when the market is especially harsh or volatile or if one is simply having an “off day.” As a result, many traders follow the one percent rule.
The one percent rule dictates that day traders shouldn’t risk more than one percent of their account on any single trade. For example, if you are trading with a $50,000 account, your maximum loss for one trade should be no more than $500.
The formula for risk is the difference between your entry price and your stop-loss order, multiplied by your position size.
Let’s suppose you purchase 1,000 shares of a stock at $35. You place a stop loss order at $34.75, based on indicators and other factors. Therefore, your risk is $0.25 per share. When you multiply $0.25 by your position size of 1,000 shares, your total risk is now $250 for the entire trade.
If you are working with a larger account, such as a $50,000 account, a risk of $250 for a single trade is manageable. However, if you are trading with a $25,000 account, you may be playing it very close to the vest.
As part of your money management strategy, you will likely lose some trades. However, capital is a day trader’s lifeline; it is how you execute trades to turn profits. With a definite stop-loss, even if you are on a losing streak and take losses ten trades in a row, you still have enough capital to work with to attempt to recover your losses by the end of the trading day.
As a result, it is usually recommended that your trading account holds more than the minimum and includes a buffer to account for your risk management strategy. Therefore, you may consider having at least $30,000 in your account if your plan to make more than four day trades per trading week. Moreover, with a $30,000 account, the most you can risk on a single trade would be one percent of $30,000 or $300.
Day Trading Capital and Assess to Margin
Day traders can usually access leverage from their brokerage firm. In other words, you are trading with margin or borrowed funds. The margin is a percentage of the cash you have in your account and comes with an attached interest rate determined by your broker.
Most day traders can access leverage up to a 4 to 1 ratio. For example, if your account has $100,000 in funds, you can probably get access to $400,000 of trading power during the day.
Even when a day trader utilizes margin or leverage, his risk management strategy, such as the one percent rule, should be applied to his actual account balance, excluding any borrowed funds.
How to Start Day Trading with Little Money
While the law dictates that traditional day traders are subject to the minimum equity requirement, you can start day trading with little money.
How to Start Day Trading with $100
Trading with a small amount, such as $100, is extremely difficult to do, but not impossible. The minimum for many brokers is between $500 to $5,000, so you’ll likely need to find a discount broker with no minimum. Fortunately, the minimum equity requirement is for U.S. stock markets only. As a result, you may consider foreign exchange (forex) trading, which does not require a legal minimum.
Alternatively, you may consider to day trade in an international stock market outside of the United States. Be sure to research the account minimums and any other day trading rules in foreign stock markets. Additionally, you will likely need to consult a tax and legal professional to understand the implications of global stock markets.
How to Start Day Trading with $1,000
If you have $1,000 in an account, you may be able to trade. You will likely be able to find a low-minimum broker.
Even though you may not a pattern day trader designation, which requires $25,000 to have a margin account, the law still requires a minimum balance of $2,000. Unfortunately, with only $1,000, this is not an option. As a result, you may be able to work with a non-margin cash account.
With this type of account, you will be able to trade stocks and options. Unfortunately, it usually takes several days for your funds to be deposited back into your account after you sell your stock. According to Regulation T, during this time, you cannot do any additional trades with funds that have not yet settled.
How to Start Day Trading with Less Than $25,000
If we study the minimum equity requirement regulation carefully, one way to be exempt from the minimum is not to be a pattern day trader. Since the definition of a pattern trader is someone who trades four times in five days, strive to make a maximum of three day trades in five trading days.
Fewer trades means that you will need to be selective on which trades you execute and confirm accurate trade signals. On the bright side, this also means that you won’t over-trade or quickly find yourself in a pile of losses.
Similarly, by executing fewer trades, you may find yourself swing trading. Swing traders are short-term strategists like their day trader cousins but hold onto assets for a more extended period, from one day to a few weeks. However, note that swing traders use different strategies than day traders, though it is possible to do both.
Many investors who want to get started but wonder, “How much money do you need to start day trading” are relieved to learn that anyone can start day trading, even with small account sizes. Of course, more funds mean more trading opportunities, which translates to greater profit potential.
It is vital to keep in mind that each trade comes with inherent risk as well as commission costs. Some brokers may charge a flat fee while others may charge a percentage of the trade. These fees eat into a trader’s profits.
It is also critical to maintain a strict risk management system to prevent uncontrollable losses. A stop-loss order is essential to minimize losses and move on to the next profitable trade. Of course, a successful day trader also has a sound strategy for choosing the right stocks in strong sectors. For example, a trader can clearly explain how selecting which tech stocks to invest in can directly impact his portfolio.
For more day trading secrets by Michael Robinson, a Venture Capital veteran and Pulitzer-price nominated writer, subscribe to Nova-X Report.