March 4, 1999
that anyone can trade stocks on the Internet, a hefty batch of "day
traders" are becoming a force to be reckoned with for seasoned traders.
Ray Johns of Daytraders.com and Marc Beauchamp, of North American Securities
Administrators Association, Inc., answer your questions.
Heymann of Helena, MT asks:
How does day trading work? Do people deposit some pre-determined amount of money to this company for trading privileges? Do they have a net-worth requirement? How do they ever complete their Schedule D at the end of the year after making dozens of trades a day for a whole year?
Beauchamp, of North American Securities Administrators Association,
Day trading firms require that customers deposit a certain amount of money with the firm to cover their trades. The amounts vary by firm. Because day trading is very risky it is not for Main Street investors. Only people who have the stomach for a lot of risk and money they can afford to lose should consider day trading. Remember: despite the glamorous and largely uncritical press day trading has received, real wealth is still made the old-fashioned way on Wall Street by investors who do their home work, seek out quality growth stocks and hold for the long term. Warren Buffett didn't get to be worth billions by day trading. Talk to an accountant about the tax implications of day trading. Obviously short-term capital gains are highly taxed.
Johns of Daytraders.com responds:
Without a doubt, to undertake day trading, it does take a certain amount of capital. Not only do many of the major on-line trading firms that cater to day traders have minimum account opening requirements (typically $5000 to $10,000 minimum), a trader typically needs to be able to buy enough shares of a stock to make a fractional gain in the price worth while. Obviously, an 1/8th or 1/2 point move across 50 or 100 shares is not worth the effort by the time you factor in taxes and trading commissions. And as mentioned above, at least in our view, trading should ideally take place on larger cap, higher quality issues [this often means higher per share prices]. The result here is that you may find yourself needing to purchase 500 to 1000 or more shares of a single stock trading upwards of $50 to $70 dollars per share (total cost for this example would be $50,000 to $70,000 for just this one trade).
And while the use of margin accounts and high ratio leveraged day trading firms (often allowing 10:1 times your true money on deposit) does reduce the capital required to get started, it greatly increases the risk of a margin call or being wiped out in a bad trade. In fact, especially with the current market conditions we are seeing, we would recommend traders use very limited if any leverage and/or margin when trading.
However, with this said, you can try your hand at trading with as little as $10,000 or $20,000 and still produce some income on a weekly basis if you are successful at trading. Of course, the question of how successful one is at trading can only be determined through trial and error - often times with error being very costly.
As to the question of net worth requirements, again we typically recommend day trading more for those individuals that have other assets in hand and to those who are not using day trading so much to create wealth, but more to enhance it. Additionally, we do not feel aggressive trading should be undertaken by those individuals that have large outstanding debts (such as credit card debt or excessive car/home loans). One point I like to make is that paying off your credit cards is an immediate and guaranteed 15 to 20 percent annual return.
Certainly an ideal candidate for day trading would likely be someone with other liquid assets, a home largely paid for and no major outstanding debt. This gets back to the point of not using money you cannot honestly afford to lose for higher risk day trading activities. One should also have a good understanding of general long term investing, the economy and the stock market as a whole, before trying to make the jump into trading for a living.
To quickly address the question of tax preparation, we would suggest all serious traders get in contact and maintain a relationship with a qualified CPA in their area - ideally someone that understands day trading and the impact it can have on year end taxes. Before doing any signification trading, it's wise to sit down and discuss not only the handling of year end tax preparations, but also to go over the ins and outs of how short term capital gains can impact you. In some cases, up to 40% of your profits may be viewed by the IRS as taxes due.
* NOTE: Additional information regarding tax loss selling and year end tax strategies is available free of charge from our site. To receive your copy, simply send e-mail to the following address: email@example.com (An automatic reply should occur within a few minutes.)