The stock market is a heavily regulated space, and this is understandable. It is a high-risk market where traders could watch all their money burn down to the last dollar. And one of the most common requirements for trading the stock market as a day trader is the $25,000 rule.
You need a minimum of $25,000 equity to day trade a margin account because the Financial Industry Regulatory Authority (FINRA) mandates it. The regulatory body calls it the ‘Pattern Day Trading Rule’.
The question now is this: are you a Pattern Day Trader?
We discuss everything you need to know about the $25,000 day trading rule, why it is important, and how to get around the limitation.
What Is the Pattern Day Trading Rule?
The Pattern Day Trading rule was designed by FINRA to limit traders to a maximum of 3 day trades for a 5 day rolling period.
To be honest, we think the rule is rather antiquated, but that is another debate to be had.
For today’s article, it’s important to understand who is a Pattern Day Trader?
First, let’s clarify what a day trade is.
A day trade is when you open and close a position (round trip) during the same trading day.
As mentioned before, you can make 3 day trades within a 5 rolling day period. If you make a 4th day trade in that time, it violates the rule and your broker will likely put a restriction on your account.
Generally, you are only allowed to violate this rule 1x or 2x max, before your broker will be required to pause trading on your account.
Let’s go over a few examples of what a ‘day trade’ is, so you have more clarity on the subject.
Suppose you believe Amazon’s stock will rise in the next few days, so you buy it at $150 per share. Before the end of the day, you sell your shares in Amazon for $155. That is one day trade.
The next day you buy Amazon stock at $155 and sell it for $158, still within the same trading day. That would be your second day trade in a 5 day rolling period.
You become a pattern day trader if you keep this pace up for two more days within the next three trading days. If you violate this by exceeding the 3 day trade limit within a 5 day rolling period, your broker will require you to put in the $25,000 minimum balance limitation on pattern day traders.
If you don’t have the equity, you will be restricted from closing any trades till your rolling 5 day trade count goes below 4.
Why Does the Pattern Day Trading Rule Exist?
If you’re wondering why the government would slap such a minimum balance & day trading restriction, here’s some history to give you a little context.
In 1974, before the introduction of electronic trading, every trade and transaction was made manually. There weren’t any day traders then because it would be a lot to open a trade only to close it a few hours later. The minimum equity in a trading account was only $2,000 then.
Then the introduction of electronic trading happened, followed by the dot-com bubble, which led to the proliferation of day trading. After this bubble crashed, many inexperienced traders who had gotten into day trading for its “quick money” lost their investments.
To prevent such a scenario from happening again, the SEC and FINRA came up with the pattern day trading rule. The idea was to limit low-capital traders from getting into the margin market, assuming that only serious professional traders would meet the $25k minimum requirement.
In our view, we are now in a completely different time and market, with very different structure and flows compared to the period the rule was created in.
What Happens if You Break the Pattern Day Trader Rule?
The first thing that will happen once you break the pattern day trading rule is that your account gets flagged by your broker. Some brokers may proceed to place your account on a 90-day suspension, while others may initiate a margin call.
If you fail to stop defying the PDT rule, you leave yourself and your equity at the mercy of the broker, and by extension, FINRA and SEC.
Is It Possible to Day Trade With Less Than $25,000?
The $25,000 mark may be a high minimum mark for many individual day traders, especially those who only want to test the waters. But many would argue that this limit is not the most effective way to prevent a large scale loss like the one we had after the dot-com bubble.
This then begs the question; is it possible to day trade with less than $25,000?
It is possible to day trade with less than $25,000. There are at least five ways to circumvent the pattern trading rule.
How To Day Trade With Less Than $25,000
Here are some ways to day trade with less than $25,000 without flouting the pattern day trading rule:
- Plan your trades
The easiest way to get around the pattern day trading rule is to plan your trades so that you don’t make over three trades within five trading days. So, if you already made three trades, don’t make another until it’s five days after the first trade. Of course, now that you only have three trades to remain below FINRA’s radar, you need to be precise about your trades. The margin for error has been reduced.
- Trade other financial markets
The pattern day trading rule covers only stocks and options. Forex and crypto are exempt from the rule. There is no government-imposed minimum balance for these two, making them viable day trading opportunities. However, you should also find out the government laws regarding these markets before trading them.
- Trade on foreign stock exchanges and with foreign brokerages
The pattern day trading rule is limited to brokerages and traders trading the US stock exchange. The rule does not apply to brokerages and stock exchanges outside the country. Thanks to this loophole, traders can simply trade stocks from foreign stock exchanges using foreign brokerages. But before you invest capital with any broker, find out the laws they operate under in their country. A downside to this method of trading with less than $25,000, however, is that there are stocks you’ll be unable to trade because they’re only listed on US exchanges.
- Split your investment among multiple brokerages
The pattern day trading rule only monitors one account at a time. This “single-mindedness” makes it possible to circumvent the $25,000 day trading limit by simply spreading your capital across multiple brokerages. You can then make up to three trades within five trading days on each account. While this method is perhaps one of the easiest ways to day trade with less than $25,000, it can limit your trading power. Because your capital has been split, you may not be able to afford some stocks. And for those you can afford, you may not be able to open sizeable positions that will earn you reasonable profit.
- Swing trade
Consider swing trading if you can’t day trade because your equity is less than $25,000. Swing trading is not too different from day trading. Only that your trades will last from days to weeks. Of course, this would require more patience, but it doesn’t require that you have an equity higher than $25,000.
There is one other alternative to the 5 options listed above.
If you were to trade a 0 DTE option (0 Days to Expiration) and let the option expire at the end of the day, technically the option is settled on the next day, even though it was opened and closed at the end of the aftermarket session.
This is not considered a ‘day trade’ according to the rule, so it’s a way to trade short term without violating the rules.
You could also make a trade one day, and hold it until the after market session. When that ends, by the time the market opens in pre-market the next day, its considered a new day, so you can close it first thing, thus avoiding the rule.
It’s not a day trade, but it is a way to trade short term.
Those are a few options to trade short term without violating the rules.
Is The Pattern Day Trading Rule Limited to the US Alone?
The pattern day trading rule is limited to the United States alone and regulated by FINRA. Any brokerage regulated by this body must follow the pattern day trading rule.
Does The PDT Rule Cover US Stocks Only?
The pattern day trading rule covers stocks and options in the US alone. Other financial markets, like crypto and forex, are exempt from the rule. Stocks on foreign stock exchanges also have no business with the PDT rule.
Mistakes To Avoid When Day Trading in the US
In a bid to outsmart the system, some traders make some mistakes that end up being costly.
- Holding trades overnight to avoid day trading
This mistake is common among novice day traders who don’t want their accounts flagged as pattern day trading accounts by holding trades overnight. Just know that holding overnight exposes you to changes in the market overnight that will be reflected in the pre-market session the next day. This unpredictable fluctuation could cost a trader losses that were not anticipated.
- Mounting trade sizes to make up for the PDT rule
Knowing that there are only three trades in five working days because of the PDT rule, some traders tend to oversize their trades, hence risking too much on a single trade.
This is a huge mistake because the trader would be increasing their risks with the increased trade size.
While you need a minimum of $25,000 to day trade on a US margin account according to the Financial Industry Regulatory Authority (FINRA), there are ways to get around this $25,000 rule.
But remember that whatever you do, make sure to practice proper risk management.