How to Avoid the PDT Rule: 4 Tricks to Use
Are you trading with a small account and under the PDT rule?
If you are in the US and using a US based broker, you might be subjected to the Pattern Day Trader rule if you’re trading with a small account under $25K. This rule could potentially limit your trading since you can only day trade 3 times a week.
In this article, we’ll be talking about 4 ways to get around the PDT rule and some useful tips I have for you if you are a beginner day trader with a small account. If you want to make that Lamborghini money, I don’t quite do that, but we do get that stable Corolla and Civic money here.
PDT Rules Overview
I remember a stupid rule my mother gave me when I was 6 where I had to ask permission every time I wanted to eat my Halloween candies from trick or treating, and I could only do so three times a week, even though the hard earned chocolates were rightfully mine. How is that even fair?
Just kidding, though. I’ve never had to deal with the PDT rule, and I never had a mother who let me eat candies either.
The PDT rule stands for Pattern Day Trader rule. It was established in 2001 by FINRA and the United States SEC. Basically, it limits how many times you can trade if your account is under $25,000. Under the PDT rule, a day trader can only place 3 day trades in a consecutive 5 day period.
To be specific, a day trade is when you open and close a position within the same day. For example, if you buy and sell a stock or short and cover a stock position, these are considered round trips. They count as a day trade.
Therefore, under the PDT rule, if you’re trading with an account less than $25k, if you decide to trade 2 round trips on a Monday and 1 more on Tuesday, then you cannot day trade again until the following Monday.
To many beginner day traders with a small account, this could be quite a limitation. Afterall, it’s your hard earned money. It's hard to accept that the SEC should be able to limit your access to buying power all in the name of “protecting investors,” but the PDT rule is not necessarily a bad thing all the time. I have some really useful trading tips for beginner traders under PDT later in the article, so hold on tight.
What are some ways for new traders to get around the PDT rule?
1. Use a cash account.
This is a little known fact that many beginner traders don’t realize. The PDT rule only applies to margin trading accounts.
Margin trading allows you to use leverage, essentially borrowing money from the broker to trade. Let's say I have a $5K margin account with Interactive Brokers. Since the broker allows me 4 times leverage, my buying power to day trade is $20K.
If I'm looking to buy a stock which we’ll say is selling for $11, as an example, my maximum size is a bit over 1,800 shares. Well, there’s also margin requirement and maintenance, but using the $5K in a margin account would subject me to PDT.
Alternatively, you can open a cash account with Interactive Brokers. Since the account is cash, you will not have access to leverage, the $20K buying power we mentioned earlier. Therefore, your true buying power is the same $5K. That means the most stock shares I can buy or sell is 454 shares, in this case.
The pros of trading with a cash account are that you are not subject to the PDT rule and the 3 day trade limitation per week. However, they do have a con: you need to wait for the cash to settle, and the settlement takes 2 days. That's the standard for most brokers.
If I decide to buy the most shares you could with that $5k account, I’d buy and sell 454 shares on a Monday. I will not have access to that cash again until Wednesday.
I know some people are getting mad right now, and you’re maybe saying, “But humbled trader, that's exactly the same as trading under PDT rule, you liar.” Easy there, friend. It’ll all make sense.
Let’s say you trade smaller sizes. Instead of using the entire $5,000 to buy a single position each time, what if you divide it up to a $500 gross exposure per trade. If you use $1,000 of your cash to day trade on Monday, you’ll still have $4,000 cash left to use on Tuesday.
You’ll also get the cash settlement back on Wednesday, and so on and so forth. Basically, if you allocate meticulously just a $500 or up to a $1,000 position for each trading day, you could be in a better position and have access to more day trades than if you were trading margin under PDT.
Yes, obviously this method would only benefit you if you had a bigger account size. If you’re trading with just $500 or $1000, you really don’t have much to work with regardless of whether you are trading with a margin account or a cash account.
2. Divide that capital up into multiple margin accounts
The second way beginner traders can avoid PDT is a variation of the first. Instead of opening one single cash account or one margin account with $5000, you divide that capital up into multiple margin accounts.
If you take $5K and split it into two separate margin accounts at different brokers, then you have a total of 6 day trades a week. You also still keep a total buying power of $20K, and honestly, that's not bad.
Fridays are usually slower and choppier, so you can basically trade once each day from Monday to Thursday. If one of those days presents you with a very nice set up such as a low float runner reclaiming VWAP and squeezing all the shorts out, there could potentially be set ups for you to use the remaining 2 trades.
Now, obviously the more capital you have, the more margin accounts you can open to access more day trades. If you have a total of $10k, then you can open 3 or 4 accounts depending on the broker minimums, and you get to have a total of 9 or 12 day trades in a week.
The next option is to marry a Canadian, move to Canada, apply for a permanent residency and open a brokerage account. Voila. It's’ that simple since we don’t have the PDT rule here in Canada.
Hmm, if I only know a Canadian trader. Just kidding!
3. Open an offshore trading account
This is the real third option. However, I don’t really recommend this, but some traders might choose to do this because only US brokers have to follow the FINRA and SEC rules including PDT.
Some offshore brokers that came to my mind are CMEG and Trade Zero. There is no PDT rule with CMEG, whereas with Trade Zero International, there is still no PDT rule, but they do not accept US applicants. American traders have to go with Trade Zero America which still has the PDT restriction.
With offshore brokers comes a lot of risks to the traders and investors since they are not regulated by FINRA. A good example was Suretrader, an offshore broker in the Bahamas. Back in 2015 and 2016, it was a really popular broker American traders went to in order to trade around the DPT rule.
However, Suretrader was shut down due to lots of controversies involving penny stock pump and dump schemes by insiders, poor record keeping and financial rule regulations. We’re not going to get into the details, but that’s why I do not recommend going this route.
If you do choose to do so, make sure you read all the reviews, fine prints and just understand the risk while regularly withdrawing funds from your account.
4. Buy and swing trade overnight
Since the PDT rule only applies to day trades, meaning you buy and sell a stock within the same day, when you buy a stock overnight and sell the next morning, that does not count as a day trade. It’s the same thing if you decide to get into swing trading for a couple of days or weeks.
Honestly, though, this brings us to the topic of costly mistakes I see beginner traders make because they’re under the PDT rule.
Here are some important tips for trading under PDT
1.Keep track of your 3 day trades
Check yourself before entering a day trade. If you break the PDT rule you might receive a warning from your broker the first time, but the second violation could result in the broker freezing your account for 90 days or until you can fund it above the needed $25K.
2. Use your day trades ONLY if you see a quality set up
Do not force trades. I see a lot of new traders under PDT, and they feel like they MUST use up all the 3 day trades for the week. If they don’t, they feel like it's been wasted.
That’s absolutely not true. If there are no A+ setups for you in this market condition, don’t force trades. That's what we call overtrading.
3. Don’t swing a stock position overnight
Don't enter a swing position just because you used up all 3 of your day trades for the week, where you are swinging a position overnight just for the sake of it, or even worse, all 3. You should never turn a losing day trade into a swing trade.
I see many beginner day traders lose track of their day trade amount on the week, and they only realize that you cannot sell their position because they used up all the day trades. They end up having to hold a losing position overnight.
What happens if a stock tanks overnight, or what happens if the shady penny stock company decides to do an offering after markets close? You should never turn a losing day trade into a swing trade. That's what we call bag holding and trading on hope.
As I've mentioned many times before, trading is a business, not a hobby, and it’s definitely not something you can pick up in 1 or 2 weeks just because you suddenly have the time to sit in front of the computer.
It takes money to run a business, and it takes money to really grow a trading account. The minimum I would recommend to start trading is at least $4,000 to $5,000. The marketing of growing a small $500 to 1 million, while working only 1 hour a day from anywhere in the world in six months is really unrealistic.
Trading under PDT is not necessarily a bad thing. If anything, it forces a new trader to be more selective and patient by only entering trades they have planned out as their A+ set up. There should be no chasing breakouts and definitely no following chatroom alerts blindly.
