When registering a brokerage account for trading stock, you can be interested in how somebody will know whether you are a bona fide “day trader”. It is easy to answer this question, because your broker will find out about this based on your trading activity.
In the USA FINRA (the Financial Industry Regulatory Authority) has established special day trading rules. According to them, if you make four and more day trades (opening and closing stock positions during a day) within five days, and such trades make up above 6% of your total trading activity for these five days, you are considered to be a day trader. Besides, in this case you should maintain the minimum of 25,000 US dollars in your account.
Requirements to the Capital for Day Trading
As far back as in 1975, before the e-trading, the minimum amount of the capital as only 2,000 US dollars. New technologies have modified the trading environment and the high speed of e-trading enabled traders get in and out on the same day.
Day traders do not hold positions at the end of each day. That is why they do not have any collateral in their margin account for covering risk and meeting the requirements of the margin during this trading day. Brokers wanted to obtain an efficient cushion against margin calls. This resulted in the increase in the equity requirement set in the Day Trading Rules.
Probably, you do not trade at the day time, but during one week you made four or more such trades, and had no day trades next week. In this case your brokerage firm will still classify you as a day trader and will maintain you on the level of 25,000 US dollars in the future.
You can comply with the requirement set to the capital by combining cash and suitable securities. In this case you must keep them on the day trading account of your brokerage firm rather than in a third-party bank or any other firm.
If before the beginning of the day trade you do not have 25,000 US dollars, you will not be allowed to day trade. You must have the funds on your account before you start day trading. Moreover, you must maintain the minimum balance in the amount of 25,000 US dollars on your brokerage account during the day trading.
On the other side, according to the pattern that complies with the requirement to the capital, day traders obtain some advantages, e.g. the possibility to trade with the additional leverage by using borrowed funds for larger bets. A day trader can trade at 4:1 leverage while ordinary stock investors (including swing traders and those who have a tendency to buy and hold) can trade with the maximum of 2:1 leverage.
Loopholes of Day Trading
If you do not have 25,000 US dollars for day trading, there are ways to get around this demand. They include alternative trading strategies and loopholes. Most of them are not ideal.
Make only three days trades for five days. This is less than one trade per day, which is smaller than the Day Trading Rule established by the FINRA. However, it means that you should choose among trading signals. That is why you will not obtain all advantages of the proven strategy.
Day Trading on a Stock Market Outside the USA
You will have to trade on a stock market beyond the USA only with a broker who is also outside the USA. Far from all foreign stock markets have the same minimum accounts or day trading rules as US3. Learn more about other markets and find out whether they suggest opportunities for day trading that comply with your needs. Before considering this approach, consult tax and legal experts to realize the consequences.
- Join the day trader’s firm. Each firm has a different structure. However, as a rule, you deposit certain equity (less than 25,000 US dollars) and they provide you with additional capital for trading, and your deposit protects them from any losses you may have. Otherwise, the firm will leverage your equity.
- Don’t hesitate to do swing trading and enter the trades you maintain more than one day. Swing traders understand the trends developing during days or weeks, instead of monitoring one-day trend that my last 20 minutes. In fact, this is not so much a loophole as the strategy change. This works for the traders who want to continue actively participating but yet do not have enough capital to comply with the rule defining the minimum for the day trading.
- Open multiple day trading accounts with various brokers. This is a less attractive variant, but if you open to accounts, you can do six days’ trades for five days: three trades per each broker. This is not an optimal decision, because if you have the limited capital, each account will probably be small, and the day trading with such small accounts will not be highly profitable. If you have small equity on each account, you are greatly limited in terms of stock you can trade, and some brokers will not accept a small deposit.
Brokers do their best to protect themselves and can impose limits on the minimum capital at their discretion if they think that somebody regularly trades during a day (even if this is lower than the four- or five-day threshold) or trades in a risky manner.
