The Most Important Loophole for ANY Day Trader
The pattern day trader rule is among the most misunderstood stock market terms out there. Specifically, I get many questions about the rule that says you must maintain a brokerage account balance of at least $25,000.
That’s a ton of money, right? I didn’t start my stock market journey with that much money — in fact, I had about half that. So, what is a day trader to do?
First, don’t make assumptions. Yes, there’s such thing as the pattern day trader rule, but it probably won’t apply to you. It’s far more complicated than most people think — and it’s advantageous for pennystockers and other day traders who don’t trade on margin.
Now, I want to cut through the nonsense unethical brokers like to spread.
They often claim that you can’t short sell penny stocks (yes you can — you just need the right broker), or that you need to trade intraday every day to get rich (no, that’s how you make your broker rich) or that you need $25,000 to truly trade stocks.
None of that is true. So, from now on, I’m forwarding this blog post to anyone who spreads or believes those lies… and everyone from Shaquille O’Neal to Justin Bieber knows I’ll do it.
What Is the Pattern Day Trader Rule?
Let’s get into the pattern day trader rule and how it might impact you.
Here’s a short summary:
Under the FINRA rules, a pattern day trader must maintain a minimum equity of $25,000 on any day that the customer day trades. The required minimum equity must be in the account prior to any day-trading activities.
So, that would suggest that, yes, you do need $25,000 to partake in “day trading activities. ”But that’s only if you fit the definition of a day trader, which is very simple.
A pattern day trader is a stock market trader who executes four or more day trades in five business days in a margin account.
Notice that last part: “in a margin account.”
As for the $25,000 figure, the confusion comes from the U.S. regulators who instituted the much maligned “Pattern Day Trader Rule.”
Understand first that brokers want you trading all of the time because they make money on commissions, and in order to trade all the time freely, you need $25,000. But if you truly want to get wealthy, you shouldn’t be listening to what your broker says.
You should listen to what actually works.
Day Trading Rules and Requirements
Let’s revisit my definition of a pattern day trader: “A pattern day trader is a stock market trader who executes four or more day trades in five business days in a margin account.”
This means that you need to execute at least four day trades in five consecutive days using a margin account. That sentence actually includes a lot of limitations.
First, a day trade occurs when you buy and sell shares in a stock between market open and close. If you hold your position overnight, the transaction is no longer considered a day trade.
I will repeat this because some people have problems believing it: The Pattern Day Trader Rule does NOT limit you from making more than three trades per week. You can hold a stock or even two or three stocks overnight, every single night, but you are limited on your intraday trading to just three intraday trades per week.
Given your small account size and likely lack of experience (hence the small account size), this is a good thing. It makes sure that you don’t churn and burn your account to ashes like too many newbies do, trying to catch every single stock and every single move up and down all over the place.
Second, you have to make at least four trades per week.That’s actually a lot of trades. I encourage my students to exercise restraint.
Many traders want larger accounts. In addition to being compliant with the pattern day trader rule, you can get more leverage if you have over $25,000 in your brokerage account.
Some brokers offer 4:1 or even 6:1, which means that, if you have just $1,000, you can now gamble with $4,000 or even $6,000.
Make no mistake — I use the word “gamble” on purpose because my top students and I do not gamble and do not use leverage. It’s very easy to lose huge chunks of money when you’re gambling with leverage because it doesn’t feel like “your money.”
So, yes, my top students and I are perfectly happy to make three or less — not four or more — day trades per week to fit comfortably outside of the pattern day trader rule.
And finally, the pattern day trader rule only applies if you’re using a margin account. If you’re using a regular cash brokerage account, you don’t need to worry about the rule.
I urge my students to avoid leverage at all costs, which means you don’t need a margin account. You can use my recommended brokers to open a cash account with as little as $500 and begin trading.
Day Trade Limit: Minimum Equity of $25,000
Let’s say that you’ve opened a margin account and you intend to make four or more intraday trades in a week. I caution you against it, but many traders ignore my advice.
In this case, you’ll need to maintain minimum equity of $25,000 in your account to remain compliant with the pattern day trader rule. Some brokers jump the gun and make assumptions based on your answers to their questionnaires or your trading activity. They’ll let you know that you have to add money to your account.
Tomorrow, I’ll be back with a continuation of this article. Giving you a full list of tips for following the Pattern Day Trader Rule, with examples of what to do, and more importantly, what not to do.
We’ll talk soon.
Editor, Penny Stock Millionaires