By Gordon Gottsegen
The pattern day-trading rule is no more
Brokerage accounts with less than $25,000 have been restricted from day trading
For many years, day trading was reserved for professionals and the wealthy – not just figuratively, but because of a restriction known as the pattern day-trading rule.
Essentially, individual investors with less than $25,000 in their margin brokerage account couldn’t place four or more day trades – which involves opening and exiting a position the same day – within five trading days. If they did, their brokerage would label them as a “pattern day trader” and restrict them from placing any more trades for weeks or months.
Now, the pattern day-trading rule is going away. The Financial Industry Regulatory Authority and the Securities and Exchange Commission both voted to remove the restriction, with the change taking effect on Thursday. Brokerages have up to 18 months to adopt these changes, but some will eliminate the day-trading restriction within days.
Read: Day trading is about to get a lot easier for beginners. Things could get ugly.
The rule first took effect in 2001 in response to the dot-com bubble. At the time, not only did new internet technologies cause the stock market to rise and crash, but they also drove a new wave of retail investors into the market and made it a lot easier for them to trade actively. The pattern day-trading rule was meant not only to protect retail investors from overtrading, but also to protect brokerages, which had to meet certain cash balance and margin requirements.
By having the limit on day trading at $25,000, regulators intended to preserve brokerage balances and protect traders with less money, while allowing investors with more money to day trade if they want.
“To me, the two intentions of rule were quite logical,” James Kostulias, head of trading services at Charles Schwab, told MarketWatch. “We want to extend to some of the more sophisticated investors additional intraday buying power, because there’s different risks associated with intraday versus overnight trading. And two, we want to make sure we’re not extending those risks to less sophisticated, less affluent investors who aren’t ready to handle it.”
However, Kostulias said, the rule ended up creating confusion among retail traders. He said that roughly 10% of client calls to Schwab’s trading support team are about the pattern day-trading restriction. Clients are frustrated when their account is restricted or they don’t understand what the specifics of the rule mean. Getting rid of the rule would also eliminate that confusion, Kostulias said.
On top of that, the $25,000 requirement may not have the intended effect. Although the $25,000 level was supposed to be a proxy for retail-investor sophistication, it meant that retail investors who really wanted to day trade had to do so with more at stake – instead of learning how to do so with a smaller account size.
“No more artificial $25,000 dollar floor is helpful,” Kostulias said. “It’s like, ‘Hey, we’re going to keep the training wheels on, and then once you get to the first really big hill we’re going to take the training wheels off.”
The overwhelming majority of day traders lose money
A handful of academic studies have analyzed retail investor day trading, and the results don’t look too good for day traders.
Around 5% of day traders are profitable, according to an academic paper titled “Do Day Traders Rationally Learn About Their Ability?” by researchers Brad Barber, Yi-Tsung Lee, Yu-Jane Liu, Terrance Odean and Ke Zhang. The overwhelming majority of day traders lose money.
Even for those who do make money, the juice may not be worth the squeeze. Another paper by Barber and Odean found that the average active investor reliably underperforms the broader market.
“You’re extremely unlikely to make money,” Alex Michalka, Wealthfront’s VP of investment research, said of day trading. “Very few people make money, even fewer make enough to make a real living of it.”
Michalka pointed to a few factors that make day trading so hard. Among them is the disposition effect, a behavioral investing phenomenon that causes people to sell their winners too early and hold onto losers for too long. Michalka said that, with day trading, investors have to be correct twice to turn a profit: once when they enter a trade and again when they exit, and timing the market is really hard.
With the deck stacked against day traders, Michalka said, the pattern day-trading rule probably helped retail investors by holding back some would-be traders. Getting rid of that rule will allow more people to day trade, but it won’t change the fact that most day traders lose money.
“I don’t think this rule change is going to change the results that retail day traders see,” Michalka said.
-Gordon Gottsegen
This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.
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06-03-26 1418ET
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