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Is Day Trading Illegal? Read Before Getting Started

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Is Day Trading Illegal? Read Before Getting Started

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You may have heard any number of misconceptions about day trading, such as that it's illegal or that it's impossible to make money. Indeed, neither of these is true.

But that is not to say that everyone should go out and immediately start day trading.

The reality is that day trading requires more up-front capital than other forms of trading. It also likely requires more time. These stipulations could be part of the reason day trading gets a bad rap.

It can also be quite risky, especially for newcomers. But those who have the time, money, and mental fortitude for day trading can do extraordinarily well.

What is Day Trading?

Day traders are similar to any other stock trader, with one key difference: they trade much more frequently. Plus, they don't buy and hold. Instead, they take advantage of price trends to buy and sell assets for a profit.

Whereas the long-term, buy-and-hold trader will hold stocks for years or even decades, day traders buy stocks and then sell them again sometimes in a matter of hours.

Day trading is essentially a buy low/sell high strategy. Doing so is easier said than done though because you must be able to predict price increases.

The good news is that you don't necessarily have to do all the predicting on your own. Later in this post, we'll cover one way you can seek some guidance on which stocks may be winners.

 
Rules Around Day Trading

The official SEC website states, "While day trading is neither illegal nor is it unethical, it can be highly risky." We'll address the riskiness part later in this post, but, for now, we've established that there are no laws that expressly prohibit the practice of day trading.

The only law all day traders must follow is the minimum equity requirement. If you are a pattern day trader, you must maintain at least $25,000 in your account at all times. That means you must trade using only money above $25,000 (though some securities can fulfill your minimum).

The SEC further notes that all money which meets your minimum equity must be fully deposited into your account before any day trading.

What is Pattern Trading?

A pattern day trader is anyone who trades at least four times during five business days, so most day traders will be constituted as such. In addition, the total number of trades must be in excess of 6% of your total trading activity over five business days.

In this context, we can see that the word "pattern" is literal: you've shown a pattern of trading often during the day. Thus, you are considered a pattern day trader. To learn more, the internet has various online learning platforms to get you going.

How Much Time Do I Need to Day Trade?

There is no "right" answer to how much time you need to day trade. Most day traders do so independently, so you aren't required to work a certain number of hours.

That being said, your typical day trader works about three or four hours a day. Just like leverage, this may sound enticing, but it doesn't quite tell the whole story.

As mentioned above, there is a lot of learning to do before you'll be ready to actively day trade - especially if you are new. It may take months of reading articles, taking courses, and practicing trades before you are ready.

Also note that you must be able to trade during the day, while the markets are open. That means between the hours of 9:30 a.m. and 4:00 p.m. EST.

As hinted at above, you do not need to be available to trade during that entire time, but all day trading must be conducted during that window. Trading activity drops during lunch as well, a little before noon, so you can expect to take a break during that time.

While day trading may only require a few hours in the day of an established trader, you can expect a learning period during which you will acclimate yourself.

How Much Money Do I Need to Day Trade?

I mentioned in the introduction that day traders need more capital to start than other types of traders. There are potential ways around this, such as using offshore brokerages, but circumventing the $25,000 requirement may mean giving up other consumer protections.

That being said, you don't necessarily need much to trade above the minimum equity requirement. Even $1,000 can be used to generate a modest daily profit.

One of the things that attracts people to day trading is the idea of leverage. Leverage allows you to trade with more money than you actually have.

For example, if you have $2,500 to trade (in addition to your $25,000), leverage may allow you to execute up to $10,000 in trades on any given day.

Note that this is only a rule put in place by the Financial Industry Regulatory Authority (FINRA). Your brokerage may have its own rules.

Of course, while leverage can be incredibly useful for the adept trader, it can be dangerous for someone less experienced. For example, if things go south fast and you lose $5,000, you'll have to cover all of it - even though you only had $2,500 to trade.

How to Avoid a Disaster

You may have heard recent stories from finance blogs of brand-new day traders leveraging huge sums of money and losing tens or even hundreds of thousands of dollars. While leverage can be as tempting as it is powerful, it's not wise to leverage that much as a new trader.

A much smarter approach is to ease your way into it. As you might expect, there are plenty of in-depth articles, videos, and courses out there to bring you up to speed. One day trading service in particular, Investors Underground, has a ton of great information and even has a chat room to give you real time trading alerts. Check out our favourite Investors Underground review.

In addition to learning the ropes before fully diving in, there are some brokerages that let you simulate real-life trading. This allows you to essentially trade with Monopoly money so you can learn without squandering your own life savings.

Day trading is certainly not easy, but with the right guidance, it can certainly be used to make some extra money or even a full-time income.

How to Get Started

You don't need much to get started day trading - other than the minimum equity, of course. Beyond that, all you need is a brokerage account.

Most major brokerage firms will allow day trading, but a quick Google search will confirm whether or not day trading is allowed.

Day trading is simple in theory, but it isn't quite as simple in reality. In addition to the things mentioned, you will need to have a lot of patience and the ability to remain positive when hiccups inevitably happen.

As you can see, the setup is the easy part. Acquiring the knowledge & skills needed to become an expert day trader is what takes more time. You're looking at many factors, including profitability ratios of a company, to determine a trade.

However, anyone with the motivation and drive can become a day trader. Start learning now, and you could be well on your way to becoming a full-time trader.

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