In comparison to other securities, implementing short-term strategies such as day trading on equities products can be capital intensive. Regulatory and broker guidelines raise margin requirements to levels in excess of many other securities. While market participants still actively day trade stocks, the barriers of entry are significantly higher than those found in the forex, futures and contract-for-difference (CFD) markets.
Regardless of monetary considerations, stock day trading does offer consistent potential opportunity. In fact, millions of participants buy and sell equities on exchanges throughout America, Asia, Australia and Europe. Although strategic considerations must be made per jurisdiction, day trading stocks can be a viable way of engaging the global capital markets.
Day Trading Stocks: Rules And Regulations
From a regulatory standpoint, there is no single international body that oversees all equities markets. Governance is established on a regional basis, with rules varying across geographic locales. Depending on the exchange and brokerage service, the minimum amount of capital necessary to day trade varies.
As far as regulations go, the standard for stock day trading is put forth by the U.S. Financial Industry Regulatory Authority (FINRA). This non-profit independent entity promotes the integrity of American markets through the "effective and efficient regulation of broker-dealers." It is the chief regulator of the U.S. stock trade, which includes more than 5,000 offerings and accounts for 43% of global equities value.
FINRA defines the act of stock day trading as "buying then selling or selling short then buying a security on the same day." This definition sets the stage for FINRA's rules on stock day trading:
- Pattern Day Trader: According to FINRA, a pattern day trader is anyone who places four day trades in a five-session period on margin. In addition, the total number of day trades must be more than 6% of the individual's aggregate trading activity for the same five-session period.
- Margin Requirements: To mitigate the risk exposure of all parties involved, a minimum balance of US$25,000 must be kept in the margin account at all times. In the event that the US$25,000 threshold is violated, trading is restricted and a margin call is issued. Upon the account being restored to minimum levels, day trading activities may resume.
- Buying Power: Pattern day traders are allowed to implement 4:1 leverage on the defined maintenance margin requirements.
If you are interested in day trading U.S. stocks, the bare minimum to participate is extensive―some quantity in excess of US$25,000. This figure is much larger than the minimum necessary for retail forex and futures accounts.
However, while FINRA requirements make active stock trading a non-starter for many U.S. retail market participants, other international locales feature more relaxed standards. Day trading guidelines and restrictions vary according to country, so more affordable options are available. Ultimately, the responsibility falls upon the trader to research regulations and margin requirements per the exchange being traded.
Maximising Capital Efficiency: The 1%-3% Rule
To answer the question of "how much money do you need to day trade stocks?" you must first address the concept of capital efficiency. In traditional finance, capital efficiency relates revenues, expenses and returns to measure how well a business is using its money. For active traders, the term is especially relevant, as risking money to make more money on condensed time horizons is the name of the game.
Aside from basic regulatory requirements, the precise amount of money needed to day trade stocks in a capitally efficient manner will vary from individual to individual. Through answering the following personal questions, an ideal monetary value will very likely emerge:
- What are my financial resources? How much am I willing to put into harm's way?
- What are my trade-related goals?
- Which markets and stocks am I going to trade? Domestic or international? Penny or blue-chip?
It is important to remember that no matter how much money is in the trading account―whether it's US$5000, US$50,000 or US$500,000―it must be able to do two things: service open positions efficiently and promote longevity in the marketplace. Goals and targeted markets must be in alignment with resources; if not, it is exponentially more difficult to maintain a positive degree of capital efficiency.
What Is The 1% to 3% Rule?
One sound way of promoting capital efficiency is implementing the 1% to 3% rule. According to this money management strategy, the assumed risk of any one trade is between 1% and 3% of the account balance. This approach ensures that the trader does not become overextended and that any adopted methodologies are given a reasonable chance at success.
The following illustration shows how Erin the stock picker uses the 1%-3% rule to dictate risk exposure. Assume Erin is a U.S.-based pattern day trader with an account balance of US$35,000:
- Erin is interested in buying 250 shares of Netflix stock at US$250 per share for an intraday scalp. It is deemed a high risk trade, therefore assigned a 1% tolerance.
- Erin's 4:1 purchasing power facilitates the purchase, covering the US$62,500 capital outlay.
- Upon the trade going live, Erin takes on a US$2.50 per US$0.01 potential liability. This means that for every US$0.01 movement in price, Erin's account balance is impacted positively or negatively by US$2.50.
- The 1% risk tolerance dictates that US$350 (1%$35,000) may be put into action. Accordingly, price is allowed to fall by US$1.40 ((350/2.50)(.01)) before the position is exited.
In order to flourish as a stock day trader, strong money management skills are required. Therein lies the answer to the question of how much money one needs to day trade stocks―as much as the risk tolerance above margin requirements will allow.
It is important to be aware that day trading stocks can be capital intensive. Regulations and brokerage requirements are often hefty, increasing maintenance margins and minimum account balances. Due to these factors, many traders view the forex, futures or CFD markets as ideal venues for short-term trading.
Nonetheless, it is possible to day trade stocks for profit. Through implementing rigid money management strategies such as the 1%-3% rule, capital efficiency may be optimised. Such methods promote longevity in the marketplace via aggressive risk management.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…