The rule requires firms that promote themselves as day-trading operations to provide individuals with a risk disclosure statement before opening an account. The National Association of Securities Dealers (NASD) drafted the proposal, which the SEC approved last week.
Regulators wanted the statement to be a sharp warning of the inherent risks of day trading. By some estimates, seven out of 10 day traders end the day with less money than they had when they began.
"Day trading can be extremely risky," the new rule states. "You should not fund day-trading activities with retirement savings, student loans, second mortgages, emergency funds, funds set aside for purposes such as education or home ownership, or funds required to meet your living expenses."
The law requires the broker to have "reasonable grounds for believing that the day-trading strategy is appropriate for the customer." The broker must "ascertain the essential facts relative to the customer, including his or her financial situation, tax status, prior investment and trading experience, and investment objectives."
Day trading is a high-risk strategy in which investors bet relatively large sums of money in hopes of small upticks in a stock. They pull all of their money out at the end of the day and typically find a new target the next day.
Day trading is the opposite of the long-term investment approach that most people take with 401(k)'s and other savings. Day trading is much riskier because unfortunate but minor events--including botched product launches, management shuffles and other unforeseen mishaps--can severely dent a stock's price over a day or week. Such one-time events have little effect over the long term.
Day trading was relatively obscure until the stock market boom of the mid- to late-'90s, which goaded many amateur investors to quit their jobs and cash in as full-time traders. But the wild stock market swings of the past year and a half, especially on the tech-heavy Nasdaq Stock Market, have dried up many investors' savings and sparked a panic among some day traders.
Last August, Mark Barton, a chemist turned day trader, gunned down nine people at two Atlanta brokerage firms before killing himself. He was apparently despondent over losing about $500,000 playing the stock market.
Seasoned day traders say the new rule will help curb some of the popularity of day trading and weed out the most uneducated investors. Many brokers have been making newbies sign similar statements for years.
"It's always good to disclose risks," said Tim McAdams, president of Pacific Online Trading and Securities, a California day trading firm that already has customers sign risk disclosure forms. "We map it all out for (customers) before they make their first trade."
McAdams requires novice traders in their firms to take trading classes and "paper trade" with no money to get a feel for the markets. After that, he recommends that customers trade in small share lots to gain experience.
The rule may also improve the industry's image. With the influx of amateur traders who became rich and then lost fortunes in the boom-and-bust market of the past year, day trading has taken on a casino-like tarnish.
"It will help an industry that in the past had a tainted reputation," said Kyle Zasky, president of Edgetrade.com, which offers software and training seminars for trading.
Some traders said experience, not legislation, is the only thing that will improve the lot of day traders. They doubt the new SEC rule will curb much of the day-trading euphoria.
"You can't learn everything you need to know in two weeks; it takes seat time," said Richard V. Rueb, executive director of DayTradersUSA, an organization that provides education and networking resources for day traders.
Rueb's rule: "No trader will be allowed to trade big bucks until they know how to trade." He thinks that beginners should trade "no more than 100-share lots until they have mastered trading."
Rueb recommends classes but strongly advises traders to spend as long as six months doing paper trades before they step up to the big leagues.
"All traders want to trade, and all traders want to make money," Rueb said, "and many don't listen to warnings."