For traders interested in getting into day trading, there is always the pressing question of how much it will cost them to get started and what is the minimum balance required for day trading.
For those traders operating in the United States, day trading is regulated by the Financial Industry Regulatory Authority (FINRA). They have a directive that all brokers must follow stating that if you have four or more day trades within 5 trading days, you will be categorized as a pattern daytrader and thus you must to maintain a minimum of $25k in a margin account.
This very fact alone puts day trading out of reach of most individuals and also lets potential wannabe traders know just how serious this business is. The rule is enforced by all stock brokers as otherwise they would be breaking the law. Additionally, the margins that many day traders work with can be very small – say .25% to 5% and thus it is their capital that allows them to make a trade in these low margins worthwhile. Commission charges can quickly eat into any profits that you may hope to make if you are only trading with small sums of money – this applies to any trading or investment model and is known as your return on investment. To illustrate consider the following example:
Lets say trader A has a balance of $100, trader B has a balance of $1000 and trader C has a balance of $10,000. They all pick the same stock valued at $2 per share. Lets also say that the commission charge for buying and selling is $10.
Now consider that the stock moves from $2 per share by an increase of 5% to a value of $2.10 per share and all parties sell their stocks. Here is a break down of where all three traders stand.
Trader A paid $10 to buy and $10 to sell, leaving him with $80 to buy shares. He was able to buy 40 shares at $2 each. When he sold, his 40 shares were worth $84 so although the stock went up by a healthy 5% he still lost $16.
Trader B paid $10 to buy and $10 to sell, leaving him with $980 to buy shares. For this he was able to obtain 490 shares that were later sold at $2.10 each giving him $1029 or a profit of $29.
Trader C paid his $10 to buy and $10 to sell and had a value of $9980 to buy shares for which he received 4990 shares. Selling these brought him a final value of $10,479 or a profit of $479.
As you can see all three traders carried out exactly the same trade but their available capital had a significant affect on their ability to make a profit. Trader A lost 16% of his capital. Trader B made a 2.9% increase but Trader C made a 4.29% profit because the commission became negligible against the actual trade amount.
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