Last Updated on 17 November, 2020 by Samuelsson
You can trade stocks how often you want in a non-margin account. However, those with a margin account and less than $25 000 need to comply with the so-called “pattern day trading rule”, that limits the number of day trades to three for every five day period.
Those traders that do not have access to such funding should instead use a non-margin account to limit their risk.
Even if the allure of leverage is hard to resist, using a normal non-margin account will lower your risks and make it more likely that you stay in the game!
What Is the Pattern Day Trading Rule?
The day trading rule works by labeling some traders as “pattern day trader” and then demanding that they have deposited $25,000 in their account in the form of cash and securities. The definition of a “pattern day trader” is provided by the Financial Industry Regulatory authority (FINRA). According to FINRA, a trader with a margin account will be called a pattern day trader when they perform day-trades for more than three times during five consecutive business days.
Please note that it’s the number of trades that counts and not the number of companies for different trades. So, if the same stock is day-traded for four consecutive days then the investor will still be flagged as a “pattern day trader”.
To Whom Does the “pattern day trader rule” Apply?
The pattern day trading rule applies strictly to those investors that use a margin account. Moreover, this is a US-specific rule which is enforced by the regulator. This means that any broker that comes under FINRA’s regulation has to comply with this rule. Cash-based traders, however, don’t need to comply with this rule!
Note: Buying, Selling and Shorting as well as any combination of the three done within a day can be considered to be day trading.
Note: the $25,000 minimum cash does not have to be in pure cash. It can be cash plus a combination of eligible securities.
Why Does the Pattern Day Trader Rule Exist?
This rule might seem bothersome to new traders, but they must remember that the pattern day trading rule exists to protect the brokerage firms and themselves. This has to do with the increased risk that brokerages face when clients with small capital gain high market exposure with the help of leverage.
When an investor invests with borrowed money, they run the risk of losing the borrowed money in unexpected events. In addition, doing day trading in itself is a risky activity. Leverage and day trading risks add up and therefore create a need for placing restrictions.
The borrowers, that is those trading with leverage, need some sort of counterweight to this additional risk. So, the $25,000 in minimum act as compensation for the additional risk exposure. This might sound unfair but banks are doing the same thing when they charge higher interest rates from high-risk customers.
Can You Still Day Trade a Margin Account With Less Than $25 000?
Please note that the advice laid out in this post is used on your own risk. Please consult a financial advisor before acting on any of the advice laid out in this article!
Most traders who have less than $25 000 probably do best in not using a margin account, in order to minimize their risk. As a beginning trader, you are going to make mistakes, and need to ensure that those mistakes don’t wipe you out completely. Therefore we urge newcomers to the market to not trade with leverage!
However, if you have the experience and knowledge that is required but lack the capital to not be restricted by the day trading pattern rule, here are two ways that you could use to try to get around it.
Open Multiple Accounts With Brokers
The easiest solution is to use three to four brokerage accounts for perform day trading. Such a strategy uses the fact that the number of transactions limit applies to an individual account. Therefore, you don’t become a pattern day trader if you perform 20 day trading transactions from 10 different accounts.
There are two ways of opening multiple accounts. First, investors can create accounts in the name of trusted family members and relatives with the same broker. So, both you and your sibling can have accounts at TD Ameritrade. Another way of creating multiple accounts is to have different accounts with different brokers. So, one can have accounts with TD Ameritrade, Charles Schwab, and other similar brokers and use those accounts to doge this restriction.
However, using multiple accounts for going-around the $25,000 limit is not a sustainable measure. Brokerage houses constantly observe their customers and its only a matter of time before brokerages start increasing their minimum collateral limit (even for non-margin accounts), tying limits to social security numbers and demanding biometric information for using the accounts. Therefore, daytraders also need to have other tricks up their sleeves.
Day trade in a Stock Market Outside the US
The day trading pattern rule is enforced by American regulators like FINRA and the Securities & Exchange Commission (SEC). Therefore, this requirement does not necessarily hold true in non-US stock exchanges. An investor can look at attractive foreign markets where the exchanges don’t have such stringent requirements. However, such a move has to be tempered by a number of considerations. These include government-related factors such as tax and legal implications as well as business factors like liquidity and currency risk concerns.
You can daytrade with less than $25 000. FINRA introduced the pattern day trading rule to decrease the risk both for clients and the brokerage firms. The rule applies to all traders who have margin accounts with less than $25,000 in the form of cash and acceptable securities. However, there are a few strategies to counter the pattern day trading rule.
If you enjoyed this article you might also like our other articles answering common questions traders have!