Day Trading With Less Than $25K: Loopholes & Alternatives
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Pattern Day Trading RuleCopy link to section
Learning how to day trade is fundamental before moving on the next steps especially because the stock market is regulated, and therefore the people who trade it are subject to regulation. The Pattern Day Trader Rule is one of those regulations, and it states that a person can’t make 4 or more margined stock day trades (which includes options) within 5 business days unless they have at least $25K in that trading account. There are some nuances here to take a closer look at.
- A day trade is any trade that is opened and closed within the same trading session.
- 4 or more day trades in a 5 day period flags that person as a Pattern Day Trader.
- Anyone who makes 4 or more day trades in a 5 day period is required to have at least $25,000 in their trading account, and if they don’t they won’t be able to make anymore margined day trades until they bring their balance up to $25,000.
- This rule applies to margined accounts, where the trader utilizes margin. Day trades are allowed to be leveraged 4:1. Meaning if you have $25K in the account, you can actually trade $100,000 worth of stock. If your account is less than $25k, and you make 4 or more day trades in a 5 day period, your margin will be reduced to 2:1 until you bring the balance to above $25,000. The broker typically provides less than 5 days to do this. If the trader has still not brought the balance above $25,000, then margin is restricted to zero thus eliminating the ability to day trade on margin.
- Once you’re flagged as a Pattern Day Trader it doesn’t go away. You will need the $25k, or each time you make 4 or more day trades in a 5-day stretch you will be asked by your broker to bring your balance above $25,000 otherwise the above steps will be taken.
- You can day trade as much as you want if you aren’t using margin. Although, shorting requires a margin account. If using a cash account, you will only be able to go long on day trades. You will not be able to profit from downward price moves, which occur regularly on a typical day. But, not using leverage may be an option for people if they are only looking to day trade strongly upward trending stocks, for example.
- This rule only applies to stocks and options, not forex or futures markets.
Exploring the Pattern Day Trader LoopholesCopy link to section
Already we can see some loopholes in the pattern day trading rule (PDTR).
You may opt not to use margin. For example, if you have $10,000 you can open a cash trading account (not a margin account) and just trade your $10,000. You can take as many day trades as you like. The PDTR rule applies to traders using margin.
There are a few hiccups with the cash account day trading approach. With a cash account, you can’t short stocks, and options strategies will also be limited to buying puts/calls and selling covered options.
Another setback with day trading a cash account is that trades take time to settle, which can be an issue with a small account. We are buying or selling something, and that cash needs to change hands. This is called T+2. It takes the Transaction day + 2 business days for the funds to settle. You can’t use funds you don’t officially have (still in settlement), which means that your cash won’t always be available for day trading. This may be okay on a large account where each trade is only a portion of the account, but for a small account where most or all of the capital is being used on each trade, there will likely be many days where the person can’t trade. Using funds that aren’t settled to make other trades is called freeriding and is a violation of Regulation T.
The rule only applies to stocks and options, not forex and futures markets which are also viable for day trading. There is no minimum legal requirement for day trading forex, although starting with at least $500 is recommended, and ideally $5,000 or more if hoping to make any sort of income. If you are interested in forex, my Forex Strategies Guide For Day and Swing Traders will walk you through everything you need.
Futures are more regulated, and there are minimum margin requirements, but they are much lower than with stocks. Controlling a single S&P 500 Emini (ES) contract only requires a balance of $400 with some brokers, and usually a minimum deposit of $1000, although starting with much more than that is recommended. To properly manage risk on a popular contract like ES, starting with at least $8,000 is preferred. The margin requirements of futures contracts vary, so this recommended starting balance could be smaller to larger depending on the contract being traded. Ultimately it comes down to controlling risk, which determines position size, which in turn lets us know what our account balance should be in order to take a trade.
I have day traded stocks, forex, and futures. They are all good day trading markets. One is not better than another, it is just preference and which one suits your life. You can also analyze what is the success rate of day trading to make a better decision.
Another option is to day trade a non-US market. Each stock market around the globe has its own regulations. While the US stock market is the biggest, it is not the only option. You may find another stock market may be more suited to your financial condition, especially if you don’t live in the US. If you live outside the US, check the regulations in your country, or a neighboring one. While these markets may not be as big, you can typically find a least a handful of good day trading candidates. I only day trade one stock at a time, often for months. So even if you can only find a few stocks with good movement and volume on that particular exchange, that may be enough.
Another, not recommended, loophole is to open multiple day trading accounts. You could then take 3 day trades in any 5 business day period, in each account, and never get flagged. On closer inspection, this is an ill-advised strategy. Even having $15,000 and spreading it across 3 accounts would mean $5,000 in each and still only 9 day trades in any 5 day period. Not only is it a logistical nightmare to manage three different day trading accounts, but the capital is also small in each. Instead of taking bigger trades with more capital, this day trader will end up taking more trades with smaller chunks of capital. Who do you think will be more affected by commissions? Trading smaller amounts in different accounts is more likely to be eroded by commissions…as well as eroding the mental state of the trade. This approach is inefficient.
Have the $25,000 to day trade US stocks and options legitimately, otherwise, trade forex or futures. Day trading in a cash account is too limiting in most cases, and day trading multiple accounts isn’t really a viable option. Day trading another global stock market is an option if you are outside the US.
Day Trading FirmsCopy link to section
There are day trading firms around the world providing traders with capital to trade, and in many cases training as well. Trading for a firm is like a job (but way awesomer), except you’re contracted and paid based on performance instead of a salary. Most firms require the trader to put up some of their own cash, which is used to offset losses or is leveraged by the firm so the trader has access to much more capital than they would have had on their own.
Getting hired by a firm isn’t easy, and once hired the competition can be stiff. Some firms offer training, but if you don’t follow the advice and aren’t making money they will cut you loose. Other firms don’t offer training, or want their traders to come up with their own strategies. While the learning approach is different, they still require the trader eventually start producing profits.
Some firms allow traders to trade remotely from home, while others require the trader to come to a physical location. To find trading firms in your area, search “proprietary trading firms” and then include your city or area. For more details on different types of trading firms, and the pros and cons of each, see How to Get Started in Day Trading.
There are day trading firms for stocks, forex, and futures. Some firms offer all three, as well as options. If you find a firm, make sure they offer the market you are interested in before applying. If you apply, expect the same procedure as any job. Here I highlighted some typical trading firm resume mistakes. If they like your resume, you will have at least one interview and often two or three. Some firms charge an upfront fee for training.
Just like any job, make sure it is the right fit before accepting an offer.
Alternatives To Day Trading – Hold Trades LongerCopy link to section
If you really want to trade stocks or options but don’t have $25,000, there’s another choice. Hold trades longer.
Day trading means opening and closing trades in the same day, but if you hold a stock for more than one day the Pattern Day Trader Rule doesn’t apply.
Day trading has its perks, but so does holding trades for more than a day:
- Fewer trades, which means fewer commissions.
- Bigger multi-day moves are often easier to take advantage of than short-lived intraday trends.
- You can still use 2:1 margin. This isn’t as much as the 4:1 day trading margin, but is more than using a cash account.
- If using a margin account (2:1) you can short and utilize all the options strategies.
- Holding trades for a few days means you are less likely to have issues with T+2 and freeriding violations.
One of the big problems for most new traders is that they overtrade. When you day trade you are just sitting there and the price is constantly moving. It lures people into low probability trades. If you limit your day trading activity, and only look at opportunities that may develop over two days or more–even over several days or weeks–you will limit the number of trades and will hopefully be more selective. At minimum, the commissions will be reduced.
Many traders also find day trading difficult because the price can change direction so quickly. A short-term trend may only last 10 minutes, and timing needs to impeccable to capture the bulk of it. Capturing part of a trend that lasts for multiple days or weeks may be easier for some people. This is called swing trading.
There is nothing wrong with day trading. I do it, but I also swing trade. Both are viable ways to trade. If you lack the skill or capital to day trade, swing trading is an alternative.
Final Word On Day Trading With Less Than $25KCopy link to section
If you really want to take full advantage of day trading stocks, save up the $25,000 plus a little extra so you don’t fall below the threshold as soon as you have a losing trade.
If you have less than $25K, your next best options are to day trade forex or futures. These markets require less capital and are also great day trading markets.
Another viable option is trading for a proprietary firm. With a day trading firm, you can trade stocks with less capital and not worry about the pattern day trading rules.
If you want to trade stocks, and are open to taking slightly longer-term trades, then swing trading is a great option. It takes up less time, doesn’t require the $25K minimum, and many people find it less stressful than day trading. I like to do both.
If you have less than $25K for day trading, use one of the alternatives above, and stay away from opening multiple day trading accounts as a loophole.
Day trading in a cash account can work, but is highly restrictive and Regulation T may mean frequent days of not being able to trade.
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