(Newswire.net — October 18, 2019) — After setting up an account with a brokerage firm to trade stocks with you may ask yourself how will anyone know whether you are a genuine day trader. Your broker will be able to tell based upon your trading habits and activities.
To help identify real day traders, the United Stated Financial Industry Regulatory Authority (FINRA) created the pattern day trader rule that declares that if or when a stock trader makes a minimum of four trades in a single day over a five day period, then that trader is deemed a day trader, and so must have a minimum of $25,000 in their account.
The requirement for increased equity
In 1974, before the days of electronic trading, the required minimum amount of equity was just $2,000. When the trading environment changed with the advent of new technology the speed at which trading could now be done also changed, and traders were now able to get in and out within the space of a single day.
Because day traders have no positions come the end of the day, there is no collateral sat in their margin accounts to cover any potentially risk and to satisfy the demand of a brokerage firm to increase the equity in the account with any given day of trading. Brokerage firms require a cushion for these demands and so the amount of equity required went up.
For those traders that do not typically day trade but so happen to make at least four such trades within a single week, but do not make any the following week, their brokerage firm would now be likely to classify them as a day trader and hold them to the $25,000 requirement for equity going forward.
The required amount of funds can be as a combination of eligible securities and cash, but regardless of this they must sit in within your brokerage firm’s day trading account and not in your own personal bank account. Meeting the $25,000 requirement does come with some benefits. It means you are eligible to trade with added leverage by using money borrowed from bigger bets. A day trader has a 4:1 leverage to trade with, whereas regular stock traders have just a leverage of 2:1.
There are some loopholes with day trading
For those traders who do not have $25,000 it is not the end of the world. There are actually some ways of getting around that requirement. These are loopholes and alternative strategies for trading, although they are not ideal.
One way is to make less than four trades over a consecutive five day period. Another is to day trade but not on US markets via a brokerage firm outside of the country. A lot of foreign markets do not have the same restrictions for day trading that are present in the US. It is advisable to do some research and see if there are markets in any other countries that suit your needs and your own financial situation. It is also advisable to talk with a licensed tax professional and a licensed legal professional before doing so, so that you are fully aware of the ramifications. A further way to work around the requirement is to join a day trading brokerage firm. It is usually the case with these that you put in a certain amount of funding, less than the $25,000, and the firm gives you additional funding to trade with. The initial amount you put into the firm acts as a deposit should you make losses that you cannot afford to pay back.
You could also partake in swing trading, entering trades which are held for longer than a single day. These traders work on trends that go over several days or even weeks, rather than throughout the entirety of just one day. This is strictly a change in your trading strategy rather than a loophole per say, it is ideal for those traders who want to remain involved but lack the $25,000 equity requirement. The final way of getting around the equity requirement is by opening multiple accounts with several different brokerage firms. By opening, for example, two accounts you can make up to six trades each day during a five day period (three on each account) and not be in breach of the rules.
Trading elsewhere
Another alternative is to find a totally different market to trade in instead. There are a few different options out there and include:
· The options market – Day trading in this market is similar to doing it on the stock market. An option is a derivative of an asset, meaning you are not required to pay upfront for it. Instead, you either receive or pay a premium to be able to participate within the price movements. As prices fluctuate over time, so does the price of the contract on the option that you hold. Depending on the types of options traded will determine the amount of capital required, but typically a few thousand dollars should be enough.
· The futures market – This is where you are able to trade commodities (oil, gold, copper etc.) and index futures of stock. A future is a leveraged product, so with $500 your position allows you to move a minimum of 10 points ($50 per point) each and every day. So as you can imagine, losses can soon mount up. It is advisable to start trading futures with a minimum of $2,500.
· The currencies / foreign exchange market – These markets are available for trading twenty-four hours per day during the working week. Currencies come in pairs to be traded, such as the Japanese yen / US dollar (JPY / USD). When trading on these markets it is preferable to start with at least $500. The markets have a leverage of, depending on the brokerage firm, around 50:1. This means that with $500 you can lose or profit as much as $25,000. Because of this you can soon get yourself into trouble.