Only 5% of day traders make money, but the SEC is now making it easier for more people to try it anyway

By Gordon Gottsegen

The pattern day-trading rule is no more

Investors were previously restricted from day trading if their brokerage accounts were valued at less than $25,000.

For many years, day trading was reserved for professional traders and wealthy investors - not just figuratively but because of a restriction known as the pattern day-trading rule.

Essentially, individual investors with less than $25,000 in a margin brokerage account couldn't place a day trade - which involves opening and exiting a position in the same day - four or more times within five trading days. If they did, their brokerage would label them a "pattern day trader" and restrict them from placing any more trades for weeks or even 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 June 4. 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 old rule took effect in 2001 after the dot-com bubble burst. At the time, new internet technologies not only caused the stock market to rise and then 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 to protect retail investors from overtrading, and also to protect brokerages, which had to meet certain cash-balance and margin requirements.

By setting the $25,000 limit for day trading, regulators intended to preserve brokerage balances and protect traders who had less money, while allowing investors with more money to day trade if they wanted to.

"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 don't understand the specifics of the rule. Getting rid of the rule would eliminate that confusion, Kostulias said.

On top of that, the $25,000 requirement may not have had the intended effect. Although that figure 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 the ropes with a smaller amount of money.

"No more artificial $25,000 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.'"

Around 95% of day traders lose money

A handful of academic studies have analyzed day trading among individual investors, and the results don't look so good.

Only around 5% of day traders are profitable, according to an academic paper titled "Do Day Traders Rationally Learn About Their Ability?" from researchers Brad Barber, Yi-Tsung Lee, Yu-Jane Liu, Terrance Odean and Ke Zhang. The overwhelming majority of day traders, meanwhile, 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 vice president of investment research, said of day trading. "Very few people make money. Even fewer make enough to make a real living off 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 on to 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 that timing the market is really difficult.

With the deck stacked against day traders, Michalka said, the pattern day-trading rule probably helped 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 of them lose money.

"I don't think this rule change is going to change the results that retail day traders see," Michalka said.

-Gordon Gottsegen

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06-03-26 2222ET