In life there is perhaps no more actionable and rewarding truth than: knowledge is power.
The more you know about anything, especially stocks, the more likely you are to be effective and profitable. All investors, be they swing, day, or long term, should be spending as much time in research as they are trading.
If they do this, then when push comes to shove they will excel where others fall flat. All the hours with your nose in a book or scrolling through chart after chart, pay off in the long (and sometimes short, if you’re lucky) run.
So you’re new to trading? Just trying to learn the basics? A seasoned day trader? You may find there's still a lot to learn. No matter where you are in you journey, here’s 10 of the most important things you should know about day trading.
Below is a quick summary of each rule, scroll down to read more details:
Practice Makes Perfect
Test out the waters with a practice account before putting money into a real account
Will help you gain practice without costing you any money.
You might feel like you are missing on opportunities to make money.
Don’t Trade In the First 30 Min.
The first half hour of trading can be very unpredictable.
Holding off for 30 minutes will let you see how the market is responding to the previous day’s news.
It is sometimes hard to back off. You might miss out on some fast action.
Avoid Trading On Margin
Only use your existing cash to trade
Using existing funds will guarantee that you don’t fall into a margin trader classification.
You have to wait until funds settle to perform another transaction.
Know Your Legal Limits
Day traders trading on margin can only trade up to 4 times in a 5 day period
Knowing your legal limit will prevent you from being classified as a pattern day trader.
If you break the legal limits you will be required to deposit at least $25K into your account
Avoid Taking Unverified Tips
If you get a tip on a stock, pay close attention at who the tip is coming from.
You will make smarter trade decisions if you trade on research
It is sometimes hard to identify the true intent of a source.
Keep A Diary
Keep a log of all your trade decisions, including when you decide not to take action.
It is beneficial to be able to go back and analyze the results of decisions you have made in the past
It is hard to be disciplined enough to keep an accurate journal.
If You’re Winning, Someone Is Losing
Remember that you can’t win every time. The good news is you won’t lose every time either.
Remembering this rule will help you to be patient and not lose confidence.
Losing is hard, especially when it involves your hard earned money.
Have A Plan
Have a plan of how many trades and how much you intend to trade for a specified period of time, and stick to that plan
Sticking to your plan will reduce the number of mistakes you make and will prevent you from trading on emotion.
The future is hard to predict, things happen, and situations change, and some plans might not work out the way you expected.
Know Your Sectors
Become an expert in a market sector of your choice.
You will be able to make more educated decisions if you know and understand the big players in your sector.
You might be tempted to trade in sectors that are unfamiliar if you see a lot of action happening.
Master Multiple Instruments
Learn to trade in instruments other than stocks such as bonds, currencies, commodities, etc.
You will have more flexibility in your trades and trading schedule.
It requires just as much effort and time each time you try to learn how to day trade in a new instrument
Rule # 1 Practice Makes Perfect
Some rules are easier than others. Although it seems easy enough, some find this rule to be the hardest to follow because it requires the most patience (more on that later).
Before you jump right into day trading, it's a good idea to practice as much as possible and gather as much information about what you’re trading as you can. If you’ve invested in the stock market before, remember that this is going to be very different. Even if you're familiar with swing trading rules, the rules here are different.
The best way to dip your toes in the waters of day trading is by opening up a paper trade account. This is an account with which you trade virtual money in a real market and can practice different strategies without the inherent risk of using your real money. With paper trade accounts you can also try different instruments and learn the rules of Forex trading, or options trading rules.
Keep practicing for as long as you think you need to feel comfortable before you put your own money in what can be the shark infested waters of the stock market. Even after you are trading with a live account it's a good idea to keep a paper account going simultaneously where you can test any theories or strategies that might not be ready for the real world.
Rule # 2 Don’t Trade Within The First 30 Min Of The Market Opening
This is one of those rules you can choose to ignore if you really know what you’re doing, but generally speaking it is a bad idea to trade within the first 15 to 30 minutes of the market opening.
The market is often in turmoil as it is getting its footing in the first half hour or so. It is hard to follow the charts and even harder (probably impossible) to know what news is going to be coming out of Washington or New York until 10 am.
Even very experienced traders avoid the first half-hour of the market opening and leave that to the experts and algorithms.
Rule # 3 Avoid Trading On A Margin Account
One of the often ignored rules of day trading is that newbies should avoid trading on a margin account.
In the simplest terms, a margin account is a loan that your brokerage gives you and is secured by funds you have in your account. You can leverage these funds for buying a higher value of stocks than you could if you only used your existing cash.
This leverage means that both your gains and losses are amplified. So, it is great if you are winning, but awful and potentially financially devastating if you are not.
In one of the other sections below we will get into the rules of trading if you do decide to use a margin account but let’s look at a couple day trading rules for cash accounts that can occur even if you are not trading on margin:
The Stock Trading 3 Day Rule
All stocks and bonds must be settled within three days. This means that if you buy a stock you must pay for it within three days. If you sell a stock the brokerage has three days to deliver the money to your account. Similarly, if you bought and paid for a stock it must be delivered to your account within three days.
The Free Riding Rule
Free riding is defined as buying a stock using unsettled funds. Remember from the stock trading 3 day rule that after you sell a stock the brokerage has three days to deliver your money.
This is considered an extension of credit. If you are caught purchasing stocks with unsettled funds your account will be suspended for 90 days during which time you are expected to fork out any cash you owe.
Running into issues with the free riding rule can be avoided by trading on a margin account but it’s important beginners stick to trading with their own cash until they get the hang of it and are confident in their trades.
Many online brokerages have features in place to prevent violations of the free riding rule before they even come up. It’s a good idea to check with yours since mistakes still can happen.
Rule # 4 Know Your Legal Limits
It is important in all things, but perhaps most of all in stocks, that you know your limits. We will go into personal limits a little more in rule # 8 but for now let's talk about legal limits.
The rules for trading in the stock market are vast and many. It’s important you familiarize yourself with them before doing anything (see rule # 1).
A very important rule for new traders to be aware of is the 25K limit. If you intend to trade on a margin account (see rule # 3), you must keep an account balance of over $25,000 to continue to day trade on margin.
It is important to note that a day trade is any trade in which a stock is bought and sold in the same trading day.
The day trading rules for under 25k accounts strictly state that no more than four day trades (as defined above) can be made in a 5-day period. If a trader with an account that has less than $25,000 USD in it continues to break this rule they will be flagged as a pattern day trader and their account will be frozen for 90 days.
To avoid some of these restrictions, one of the largest online brokerages, Interactive Brokers’ pattern day trader rule automatically prohibits the fourth transaction of a trader if their account has less than 25K USD. Many other brokerages have followed suit and protect their customers in this way.
Accounts that are not day trading on margin are subject to separate trade rules and have a little more leeway than those on margin.
Rule #5 Avoid Taking Tips From Unverified Sources
Besides insider trading, which is a serious problem in our stock market, taking tips from unverified sources can lead you down the road to losing a lot of money.
You see it’s important to remember that in the stock market if someone is making money, someone else is losing it.
There are a myriad of “sources” on the internet that will try to get you to make one trade or another by having insider information but you must always ask yourself what have they got to gain by you listening to them?
Often they will be pumping up a stock's worth so that they can sell it before you do, at the right time, and take a profit while you watch it tank. Sometimes they may be running other scams or even engaging in insider trading.
Whatever the case may be it is important to turn down the noise and focus on your plans. Never act out of emotion in the stock market or you may pay for it dearly.
Rule # 6 Keep A Diary Of Your Trades
Experts the world over swear by this. Keeping a record of your trades will help you make clearer decisions while keeping track of your mistakes so that you (hopefully) never make them again.
Experts don't often share trading rules (unless they have something to gain from it), so when they do it’s time to take note. Many mistakes on the stock market have been avoided by smart traders keeping track of past trades and future plans and acting on them accordingly.
Although no 2 trades are ever alike, you will often encounter situations that resemble each other. It is always beneficial to be able to go back and see what you did last time, and what the outcome was of your actions.
Here is a great tutorial from InformedTrades.com on how to keep a good trading journal:
Rule # 7 If You’re Winning Someone Else Is Losing
The stock market is brutal. The day’s winners are clearly defined by how much money they take and losers by how much they lost.
When you start day trading it is important to remember that--and perhaps most importantly of all--in the beginning you may be the loser more than you win.
Believe it or not that's an important part of the process. When we put it all out on the line and lose, we learn. It can be a growth opportunity if you let it. Or you can keep making the same mistakes over and over, or continue to throw good money after bad and make someone else rich.
If you pay close attention to rule #6 above, and keep a good journal, you will quickly learn from your mistakes and will be able to slowly perfect your trading strategy.
Read on to find out how to not let that happen to you.
Rule # 8 Always Have A Plan (and stick to it)
If you’ve followed all the rules up to now you likely have a system in mind for how to get ahead in day trading. It has hopefully proven itself in your paper trades, the strategy is sound, and you are ready to jump into the big-leagues and do some trading.
Suddenly, you find that there is more passion involved because you are now playing with your own (very real) money. Do not panic! Now is the time to remind yourself to stick to your plan! If it needs tweaking, do so, but always stick to your plan.
Never invest more than you can afford to lose, never make decisions at moments when you are feeling extreme excitement or anger. Plan on how many trades per day you intend to make and stick to your plan. Most of all, remember as we mentioned in rule # 5, tune out the crowd and be patient.
Rule # 9 Know Your Sectors
An important day trading rule is that you know your industry sectors and stick to them. There are traders who are strong and effective in the biotech industry that wouldn't know their knee from their elbow if you threw them into industrial goods. This is why it is important to know your strengths and play on them.
If during your study and practice period, you found that you were especially adept at understanding the healthcare industry then delve in deeper when you are actually trading. You need to know your sector (or sectors) like the back of your hand.
Sometimes you will notice a lot of action happening in a sector that you are unfamiliar with, and you will be tempted. Refrain from doing that out of impulse.
If you want to dive into other sectors, it is important that you treat the process as you would when you were first starting out. Know that different sectors react differently to movements and news in the market. Consume all the trading information you can about your chosen sector, become an expert, and the payoff could be massive.
Rule # 10 Master Other Trading Instruments
When people think day trading they usually are just thinking stocks.
In truth there are so many different trading instruments that one could day trade that are worth a closer look. You can trade stocks, bonds, commodities, currencies, derivatives and just about anything of high value.
You will find that there are different day trading rules for options and Forex so familiarize yourself with them before you jump in. Most, if not all, have paper trading platforms where you can practice your craft.
Some people trade only one of these options while others like to trade multiple. For instance, you can day trade stocks during regular hours then switch over to the Forex market that is open almost 24/7. Mastering different trading instruments means more potential upside for you in your day trading activities.
If you’ve made it this far, hopefully you have learned a thing or two (or ten) about day trading.
And hopefully it has inspired you to look a little closer at some of the subjects we covered or even try your hand at day trading.
While it may seem daunting at first, giving it a little practice, and applying the rules for trading stocks will go a long way.