You’re obviously not a defiant trader. However, infringing the pattern day trader rule is easier than you may think, particularly during instances of high market volatility. Don’t be a victim of this too. The stock market is regulated, and therefore anyone who trades in it is subject to regulation.
Here’s how you might get knocked out: If you execute 4 or more intraday trades within 5 business days with a margin account whose portfolio value is less than $25,000, you’ll have in all innocence violated the pattern day trader (PDT) rule. Now your trading account is marked. Oops! What next?
You’re already in trouble, but what are the consequences? What if you repeat the same mistake? What if you can’t meet the $25K account minimum? More importantly, what must you know to circumvent this red line in the future? While the rules that define day trading are strict, there are ways you can day trade without the $25K account minimum. Let’s go over the basics.
Pattern Day Trading Rule
Simply put, a day trade is what takes place when you open and close one or multiple security positions on the same day. Let’s break it down further:
- Open and close (round trip). When we mention “open and close,” it means buying and selling, or, selling and then buying (for short-sellers).
- Position. Day trading rules apply to almost all securities — stocks, ETFs, and bonds.
- Same day. If you take a round trip within the same day, it’s considered a day trade. Holding your security position beyond the close of the trading day isn’t considered a day trade.
The Pattern Day Trade Rule was established by the Financial Industry Regulatory Authority (FINRA) in the U.S. You’re considered a pattern day trader if you make 4 or more trades within a rolling 5-day period, and the trades comprise more than 6% of your total account activity within the 5-day period.
You’re typically limited to a maximum of 3 trades in a 5 trading-day period, unless your portfolio value is at least $25,000. As tricky as this may sound, it simply means that if you place a fourth trade within the 5 trading-day period, you’ll get the pattern day trader designation and must maintain a portfolio value higher than $25,000 to continue trading the next day. Your portfolio value includes the sum of your cash, stocks, and options. The value doesn’t include your cryptocurrency positions.
Your portfolio value might fluctuate above the $25,000 value at some point during the trading day but your brokerage only takes into account the closing balance of the previous trading day. Most brokerage accounts will let you verify whether you’re restricted from day trading or not on a particular day under the Account Management section.
Remember, the 5 trading-day period may not necessarily align with your calendar week. For instance, Wednesday through Tuesday may be considered a 5 trading-day period. Place a 4th trade on the 5-day window and your account is flagged for pattern day trading for 90 calendar days — you won’t be able to place any day trades for 90 days unless you raise your portfolio value above $25,000.
Continuing to trade with a portfolio value of less than $25,000 while you’re flagged as a pattern day trader will only result in further restrictions, including suspension of your buying power for 90 days. This is a big hassle if you had no real intention to day trade. Contact your broker who may provide some alternatives to avoid getting trapped by these trading restrictions.
Day Trading Methods on a Small Account
Since the $25,000 portfolio value requirement is mandated by FINRA, all brokerages must enforce it. Even so, you can still successfully day trade stocks, bonds, ETFs and options with less than $25,000 in your trading account, and we’ll explore a few of those methods below.
Opening Multiple Brokerage Accounts
Most day trading educators recommend beating the PDT rule by opening multiple brokerage accounts. You’ll receive another 3-day trades within a rolling 5-day period for every additional brokerage account you open. Unless you’re using the scalping strategy, 6-9 trades per week will suffice most traders — so opening multiple brokerage accounts remains a viable option.
- For every additional account, you get 3 more-day trades per 5-day trading period.
- Most discount brokerages offer commission-free trading
- You may spread your cash too thin, hence smaller position sizes
- It more difficult to track your P&L and cumulative positions
- You’ll have a ton of paperwork to compile during tax season
Opening a Cash Account
The pattern day trade rule doesn’t apply to cash accounts — you can make as many trades as you please. The only caveat is that you must trade with settled cash, and it’s the reason why margin accounts still remain the de-facto trading account in the U.S. The SEC’s cash settlement rules state that when you liquidate positions in your trading account, you must let the cash proceeds from the transaction settle. This implies that you can’t use the cash for 2 days after the transaction date.
Cash accounts are a great option if you’re approaching day trading to gain more experience rather than a quick-fix profiting opportunity. You can make several day trades without worrying about the PDT rule.
- Unlimited trades per day
- Great if you want to gain trading experience
- Great if you want to take smaller position sizes
- You must have settled cash to execute trades
- You probably won’t utilize most of your account capabilities
Limit Yourself to be Under the PDT Rule
Having one margin account is the only way to limit yourself under the PDT rule — after all you may not need in excess of 3 day-trades per week. Moreover, this restriction could serve as a positive for you. Owning a small trading account doesn’t necessarily translate to little successful trading experience.
- It can lower the rate of your loses
- It may enforce disciplined trading
- You can’t make more than 3 day-trades in a rolling 5-day period.
Day Trading on Different Markets
You can also take advantage of the day trading loopholes mentioned above by changing markets. Forex, futures, and options are viable day trading markets.
Forex is a 24-hour 5 days a week market (also called currencies market), unlike stocks that are only actively traded between 9:30 A.M. and 4:00 P.M. Eastern Time. Currencies typically trade in pairs, say GBP/USD or EUR/USD, and it offers more options for anyone looking to day trade. Profits and losses can also pile quickly.
The futures market lets you trade stock index futures, like the E-mini S&P 500, and commodities like oil, gold, and copper. Futures are inherently leveraged, so a small amount of capital gives you a position in a product that moves 10 or so points a day. Each point is usually worth $50. Similar to forex, profits and losses mount really quickly, so the amount you choose to start trading with will depend on your risk tolerance and the contracts you trade.
Day traders can also leverage the options market — a derivative of an underlying asset like a stock. Instead of paying the upfront cost of the asset, you pay a premium for taking part in the price movements of the underlying asset. The value of your contract changes as the price fluctuates.
Swing trading is a short-term trading strategy through which traders look to profit off price movements over a period of weeks or days. Since trading occurs over more than 1 day, swing trading isn’t subject to the PDT rule.
Unlike in day trading, swing traders can start placing trades immediately since there are no special capital requirements if you hold trades overnight. And as long as you hold your position overnight, you won’t be flagged as a pattern day trader.
Swing trading is also a good way to build your trading account — the small profits you make with your trades can build your portfolio with time. Swing trading is a good place to start if you want to transition into active trading but don’t own a large enough account or have little time dedicated to trading.
Getting dinged for violating the pattern day trader rule isn’t fun. And if you decide to play the day trading game, you’ll probably be squaring it out with professional traders. Of course, if you’re looking to be a more active trader, you’ll need to brush up on the pattern day trading rules. But if you can steer clear of breaking these rules, explore other trading methods, or simply maintain your account value well above $25,000, you’ll have little to worry about should you need to execute short-term trades.
Day trading in a cash account may work, but it’s highly restrictive and regulations could mean more days of not being able to place trades.
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