The most frustrating aspect of the stock market for traders is the dreaded pattern day trader rule. Although it is a huge pain in the ass, it does serve a purpose. The PDT rule was introduced by FINRA to prevent beginner traders from blowing up their accounts. During the height of the dot-com bubble, it seemed as though everyone was trying to make money as a day trader. Back then it was the wild west; there was no protection for those who were inexperienced. 90% of beginners had no clue what they were doing and ended up losing almost all of their capital. The rule no doubt has had a positive impact on the market but it does act as a barrier for serious traders looking to grow their accounts. Finding a way to remove PDT status is tricky but it can be done. Below I mention eight ways you can leverage to avoid day trading restrictions for accounts under $25,000.
- What is the Pattern Day Trader Rule?
- 8 Ways to Workaround PDT Rule
What is the Pattern Day Trader Rule?
According to FINRA, the pattern day trader rule means you can’t place more than four day trades within five business days provided that the number of day trades is greater than 6% of the total trading activity within that same five day period. The PDT rule requires every margin account to maintain a minimum of $25,000, in order to trade without limitations. If you have less than $25,000 in your margin account at any time, you are classified as a pattern day trader. In the event it falls below $25,000, your broker will issue a margin call and you will have a maximum of five business days to deposit the necessary funds.
8 Ways to Workaround PDT Rule
1. Open Multiple Accounts With Different Brokers
By opening accounts with multiple brokers, it increases the number of day trades you can execute in a five day time frame. For example, if you sign up for three accounts with three different brokerages it triples the number of trades you can place without being classified as a pattern day trader. The only problem with this method is the more accounts you have, the more complicated filing taxes will become. Despite the tax issue, this is a legal way to bypass the PDT rule. Brokers I recommenced with this method include Etrade, Charles Schwab and TD Ameritrade. They all have low account minimums and provide the best overall value. Don’t be cheap, pay commissions for better executions. Resist using free brokers like Robinhood because their fills are poor, so you’ll be at a massive disadvantage.
2. Open an Account with an Offshore Broker
Offshore brokers such as TradeZero allow you to bypass the PDT rule. They are located on the tropical island of the Bahamas. TradeZero doesn’t accept US customers, so they are an option for international traders. As their name suggests, they offer free limit orders and charge $0.005 for market orders. The main downside to TradeZero is they get paid to route their order flow to certain market centers. This means you’re likely to receive bad fills. Once again there are tax implications to consider before signing up. Asking a CPA for advice would be the best option on this matter.
3. Open a Cash Account
According to the SEC, the PDT rule only applies to margin accounts; there is no mention of cash accounts. Trading with margin allows you to borrow money from their broker to purchase a stock. If you’re not borrowing money from your brokerage, then you’re avoiding the regulation. The primary drawback of using a cash account is that it can take two days to settle a trade and for the money to arrive back into your account. If you exceed the three trade limit, your account will be flagged and you will be suspended for 90 days. Also without leverage, you have less buying power and you’re unable to short sell penny stocks. Short selling penny stocks are one of the most popular strategies right now. If you just have the ability to buy then you’re missing out on the profit potential of the downside.
4. Borrow Money from Family or Friends
If you have $20,000 and need an extra $5,000, asking a family member for a loan is an option, albeit slightly desperate. In an ideal world, it would be better to get a loan from your parents. Just tell them you won’t actually trade with their money, you only need the money in your account to meet requirements. I personally wouldn’t feel comfortable asking friends for a loan. Definitely, the best way to test the strength of your friendship. Also, avoid bank loans or peer-to-peer lending websites where the APR is high. Although receiving a loan is risky at least you will be able to select the best broker available.
5. Trade with a Prop Firm
There are several large prop trading firms in the United States that are looking for talented traders. Some prop firms provide training and the chance to trade with real capital, taking a percentage of your profits in return. Be warned; not all prop firms are legit. Some firms just make money purely by charging expensive commissions and seat fees. About $5,000 is the minimum requirement to join a pop firm and you can get around day trading restrictions.
6. Become a Swing Trader
Swing trading is a short-term strategy that is a suitable alternative to day trading. It involves owning a position for more than a day, typically 2-6 days is the average holding period. Swing traders use technical analysis when searching for stocks that could have momentum. Little or no fundamental analysis is ever used. Swing trading can be riskier than day trading because you hold positions overnight. Working up in the morning to discover you’re down 20% is a horrible feeling. Exiting your position before the market closes will help you sleep a little easier.
7. Split Broker Account Wash Tactic
The split broker tactic is quite similar to opening up multiple accounts but with a slight twist. This method is only for advanced traders, not beginners. E.g. you buy 100 shares of Apple in broker number one. Once you’re ready to sell the Apple shares, you short sell Apple using broker number two. Now you should be almost even on the trade. The next day you simply close each trade from both accounts without using any of your three day trades. Note you might lose a small amount on slippage, depending on the bid/ask spread. Wash trading was declared as illegal by the CEA. It’s a shady tactic stock promoters use to manipulate the price of penny stocks.
8. Trade Options
As stated by FINRA, the PDT rule does also apply to options trading except if you’re using a cash account. The best thing about options is that it only takes one day to settle a trade while stocks take 2-3 days. Trading options are similar to stocks but have more complicated strategies. All the different terms such as puts, calls and derivatives confuse the average investor.
One positive aspect of options is that it requires less capital. For example, if you want to purchase 20 shares of Google it would cost nearly $20,000. On the other hand, you can buy a call option at $100-$200 and can make a hefty profit if the trade goes your way. Keep in mind, Forex and futures are not subjected to the pattern day trading regulation. Forex is crazy; regulation is virtually non-existent! Avoid Forex like the plague; all that leverage is too dangerous.
There is no secret loophole to avoid the pattern day trader rule without any drawbacks. Day trading is already difficult enough without restrictions making your life harder. Signing up with an offshore broker to overcome the regulations is too risky in my opinion. TradeZero is too expensive for people with small accounts but people will still sign up out of desperation. Hopefully, someday the SEC will lower the minimum to $10,000, that would be a reasonable amount. In the meantime, people with small accounts will continue to suffer.