Introduction
You have created a brokerage account for trading stocks. Now you may wonder how anyone will know if you are a true day trader. Your broker will know this based on your trading activity. The Financial Industry Regulatory Authority (FINRA) in the United States has set a rule for “pattern day trader,” which states that you are considered a pattern day trader if you execute four or more day trades within a five-day period in your margin account, and those trades represent more than 6% of your total trading activity in your margin account during that time. (Day trading is the act of opening and closing a position within the same day). If you are a pattern day trader, you must maintain a minimum account balance of $25,000.
Background on Capital Requirements for Day Trading
Since day traders may not hold positions at the end of each day, they have no collateral in their margin accounts to cover the risks and meet margin calls during a specific trading day. Brokerage firms wanted an effective cushion against margin calls. This led to increased capital requirements.
You may not typically day trade but conduct four or more of these trades in one week, with no day trades in the following week or the week after. In this case, your brokerage firm is likely to classify you as a pattern day trader. You will be subject to the $25,000 capital requirement in the future. You can meet the requirement by providing a combination of cash and securities. However, these funds must be present in your day trading account with the brokerage rather than in an external bank or another company.
Note: If you are a pattern day trader and do not have $25,000 in your brokerage account before any day trading, you will not be allowed to day trade. The funds must be in your account before executing any day trade. On the positive side, day traders who meet the capital requirements receive certain benefits, such as the ability to trade with additional leverage – using borrowed funds to make larger bets. A day trader can trade with leverage up to 4:1, while regular stock investors (including swing traders and those who tend to buy and hold) can trade with a maximum leverage of 2:1.
Loopholes in Day Trading
If you do not have $25,000 for day trading, there are ways to circumvent this requirement. These consist of loopholes and alternative trading strategies, most of which are less than ideal.
Make only three day trades within a five-day period. This is less than one trade per day, which is below the day trader rule established by FINRA. However, this means you will need to select the right trades from valid trading signals. You will not get the full benefit of a proven strategy.
Day trade in stock markets outside the United States. You will need to do this with a broker outside the U.S. Not all foreign stock markets have the same account minimums or day trading rules as the U.S. Research other markets and check if they offer day trading that fits your needs. Consult tax and legal professionals before taking this approach.
Join a day trading company. The structure of each firm varies, but you typically make a deposit much lower than $25,000. They provide you additional capital for trading, with your deposit protecting you from losses you may incur. Otherwise, the company uses your capital directly.
Do
weekly trading and enter trades that you hold for more than one day. Weekly traders capture trends that last for several days or weeks instead of trying to time a one-day trend that may last for 20 minutes. This is less of a loophole and more of a strategy change, but it works for traders who want to participate but do not yet meet the $25,000 requirement for day trading.
Open day trading accounts with different brokers. This is a less attractive option. However, if you open two accounts, you can make six day trades over a five-day period – three trades for each broker. This is not the best solution. If you already have limited capital, each account is likely to be very small. Day trading with small accounts of this size is unlikely to generate much income. With small amounts in each account, you have restrictions on the stocks you can trade. Some brokers may not accept small deposits.
Note: Brokers seek to protect themselves. They may impose minimum capital restrictions if they believe someone is trading daily on a regular basis (even if it is below the threshold of four trades/five days) or trading in a manner that is deemed risky.
Day Trading in Different Markets
A better option than exploiting a loophole or adopting a different trading strategy is to change markets.
Forex
The forex or currency market trades 24 hours a day during the week. Currencies trade in pairs, such as the US dollar/Japanese yen (USD/JPY). When trading in the forex market, you should start with an amount of at least $500, but a larger amount is preferred. The forex market offers leverage up to 50:1 (although this varies from broker to broker). So, a $500 deposit means you can trade and gain or lose an amount of $25,000 in capital. Profits and losses can accumulate quickly.
Futures
The futures market is where you can trade contracts for equity indices (like E-mini S&P 500) and commodities (like gold, oil, and copper). Futures are a product that is inherently leveraged. A small amount of capital, like $400 or $500 in the case of a mini contract, gives you a position in a product that typically moves 10 points or more a day, with each point worth $50.
Note: It is preferable for futures traders to start with at least $2,500 (if they are trading contracts like a mini contract), but this will vary based on risk tolerance and the contracts being traded.
Options
Trading options in the options market is another alternative. An option is a derivative of an underlying asset, such as a stock, so there is no need to pay the upfront cost of the asset. Instead, you pay (or receive) a fee to participate in the price movements of the underlying asset. The value of the options contract you hold changes over time with the volatility of the underlying asset’s price. The capital you need depends on the type of options you are trading, but it can start at several thousand dollars.
Conclusion
While day trading requires a significant amount of capital, there are loopholes and other investment options that may require you to put less of your money at risk. Before investing any funds, you should always consider your risk tolerance and explore all available options.
Frequently Asked Questions (FAQs)
How do you choose stocks for day trading?
Day traders typically do not care about business fundamentals like profitability or growth. Instead, day traders look for volatile stocks that are likely to experience significant price changes in short timeframes. Day traders also seek technical chart patterns that provide some statistical probability about upcoming price movements. Stock screening tools can help you find these opportunities.
Do
Is buying four limits in one day considered day trading?
You can buy whatever you want without using one of the three non-day trades for the week. Those purchases will only become day trades if they are sold by the end of the day. Each sell order will create a day trade, so you can buy four times in the morning and place a sell order in the afternoon to count as one daily trade.
Why don’t day trading rules apply to futures contracts?
The futures market is completely different from the stock market. They are traded on different exchanges, and most of the rules are regulated by different regulatory bodies. The futures market is largely regulated by the National Futures Association and the Commodity Futures Trading Commission, and these organizations do not have the same requirements as FINRA.
Source: https://www.thebalancemoney.com/how-to-day-trade-stocks-with-less-than-25-000-1031365
Leave a Reply