How To Day Trade With Less Than $25,000

This post has me in a bit of a conundrum.  I am writing about something that I am not totally on board with but recognize as a necessary evil; day trading with less than $25,000 in your account.

Day trading is definitely one of the hardest things that somebody can do, and the ideal way to do it is to have a well-capitalized account and some practical experience in riding the intraday lightning.  The obvious financial issue is that not everybody can afford to drop 25K+ into a trading account to get day trading privileges, and the experience issue ends up being a “chicken or the egg” scenario.

I know that some of you are shouting at your screens now, and not just because a trade is going against you.  You’re yelling “Hey Poindexter, how about paper trading?”  Well, I don’t believe in paper trading, a point I made again in my recent post about finding a trading mentor.  My alternative is to trade small position size until your skill/equity level gets to the point where you can start to scale up.

That post prompted a lot of emails posing the question, “how can I get practice/experience day trading since I don’t have $25,000 to put in my account?”  This then is my answer to that question.

The Rolling Five Day Method:

This is the best, and I believe, safest method for day trading a sub-25K account.  You are allowed to do three day trades during a rolling five-day period.  You won’t get 4x buying power, but you can use regular 2x margin for your trades.

I like and recommend this method most because it forces you to be more discriminating in your trading choices.  If you see a number of mediocre setups one day, you are more likely to pass on them and wait for better ones on another day since your dry powder is limited.

The Split Brokerage Account:

So let’s say that you have only 10K to trade with, and you are dead set on day trading (…you know there is something called “swing trading” and “position trading” too).  You can split your funds in half and open two accounts with two different brokers.

By doing this you will effectively be able to do six day trades on a rolling five-day basis (once again only with 2x margin buying power), which should be more than enough for a beginning trader.

In the past, this would be an awkward way to execute trades, but the ease in which you can now open accounts, transfer money, and trade online makes it definitely a viable option.

The Split Brokerage Account Wash Method:

Same set up as above, but if you insist on having an almost unlimited ability to day trade a sub-25K account, this method will appeal to you.

For example, you take a long trade of 50 shares in XYZ in broker #1.  When you are ready to “close the position” you just sell short 50 shares of XYZ in broker #2, effectively making you flat.  You can then close each side out the next day, without using up any of your three day trades.

Obviously, you will incur some extra costs as you will have four commissionable events instead of two, as well as a bit of slippage depending on the width of the spread on the stock you are trading.  Because of this, I suggest you only use this method if you are trading with a per share commission set up.

If you are trading small (25-100 shares), you will most likely only incur a minimum ticket charge per side (usually $1.00) and the slippage costs, if any, will be negligible.  It’s a small price to pay for almost unlimited day trading ability with a sub-25K account.

One last note on the “Split Brokerage” options.  I highly doubt it, but it is possible that in the mounds of SEC regulations that exist, there might be some rules against trading two separate brokerage accounts in this related way, but if there is A) nobody is monitoring it, and B) really, what would the “penalty” be?  I think I can safely say that for all intents and purposes, this is completely allowable.

Prop Trading:

There are a number of prop trading firms out there that you can trade with, either on their floor or “virtually.”  These firms allow very small account minimums (often as low as $5,000) and you can trade with the firm’s capital which allows you full day trading buying power (sometimes more) and no day trading limit restrictions.  You also can usually trade with a micro-commission structure.

Of course, as you might guess, there is no such thing as a free lunch.  When trading with a prop firm you don’t get to keep 100% of your profits, you get a “payout” percentage based on a number of factors.  You also may have to do a minimum number of trades or pay a fee to use their platform.

I have never used a prop shop myself but know traders who have.  I have heard good and bad stories, so if you choose to go this route, make sure you fully investigate them and get some references before you commit.

Futures Trading:

There are no day trading restrictions on futures and since you are only required to put up a small percentage of your overall contract size, leverage is more than you will need.

That being said, if you are in any way thinking about trading gold ($GC_F), oil ($CL_F), wheat ($ZW_F), or basically anything other the E-mini’s, just send me 95% percent of your trading funds and ask your friend to slam your head in between his car door.  That you way you will end up with more money and still feel better that you would otherwise.

The S&P 500 E-mini ($ES_F) and the NASDAQ 100 E-mini ($NQ_F) are the ONLY futures contracts that a beginning trader should try to day trade.

Even so, it is still tough for a lightly capitalized trader to trade $EF_F as each point is equal to $50.00 ($12.50 per tick, four ticks to a point).  If you have a 5K account, only one point would equal 1% of risk capital which does not give you much room to be wrong.  You would probably want to have a minimum account size of 10K+ in order to effectively trade the $ES_F.

The $NQ_F is only $20.00 per point ($5.00 per tick, four ticks per point), but moves faster, farther, and more erratically than the $ES_F.  I have spent the last two years trading $NQ_F, and even with over 30 years of experience trading equities I still find it challenging at times.

No matter how hard you want to day trade with a sub-25K account, be forewarned that futures are a very, very tough and specialized asset class, and only a few traders will ever be consistently profitable with them.

Forex Trading:

Like futures, forex has no day trading restrictions and ample leverage for small account traders.  There has also been a proliferation of resources for learning about forex trading over the last few years.

One of the benefits of trading forex over futures is that you can have a minimum size position that better relates risk-wise with a small account.  As a beginning day trader you should stick will the most liquid crosses like the EUR/USD ($EURUSD).  If you are going to try to trade something like the EUR/TRY (Euro against the Turkish Lira), once again, put head in car door……

Currencies have their own set of challenges.  They do not trade like equities, however, many traders feel that they do more closely respect the “rules” of technical analysis. Fortunately, there are many great currency traders out there to learn from.

Conclusion:

So there you have it, how to get around the system, beat the “man,” and be a trading vandal.  Just make sure you always keep risk foremost in your mind so that you can graduate from this level of trading and make it to a fully funded day trading account.

3 Ways The Exchanges Screw With Your Stop Orders

There are a number of topics that come up on a regular basis among traders, but the most common discussions usually revolve around the theory that markets are rigged.

Well, I can tell you with 100% certainty, they are rigged. Plain and simple, the markets, specifically the exchanges, are totally geared towards screwing the retail investor.

So instead of engaging in a quixotic attempt to change things, educated yourself as to how it is rigged, and then use that knowledge to your advantage.

In that spirit, let me fill you in on the three most common ways you can get screwed when using stop orders.

*Note: when referring to stop orders going forward I’m referencing a standard, plain vanilla stop order, opposed to a stop limit order.*

Triggering stops without a trade at your stop price

Here’s an example;  XYZ is currently trading at $20.50, and you have a stop order in to sell at $20.00. Price approaches your stop, it gets triggered and you are filled at $20.05. But when you look at your chart you notice that the low price of the day is $20.04.

So how was your stop triggered?

When you put a stop order in, what you are doing is placing a market order, which for lack of a better word is in a “suspended” state.  It is not active until your stop, or trigger price, is hit. Once it is, your market order is then live and acts like any other market order.

But what you might not know is that there does not have to be an actual trade at your stop price to trigger the market order.  Only a quote needs to be shown at your stop price to trigger your order, which can then be filled at wherever price the market is trading at.

Reprioritizing your order

When there are two stop orders at the same price sitting on an exchange, the priority goes to the one that was placed first.  So if XYZ is trading at $20.50, and there are two stop market orders at $20.00, when price comes down and triggers those stops, the one that was placed first will get filled before the other one.

However, this all changes if there are also stop limit orders at the same price. Stop limit orders at the same price as a stop order will get priority, and will be filled first, even if they were placed after the stop order.  In fact, stop limit orders below the price of stop market order can still get priority over a stop order.

The “philosophy” behind this exchange rule is that by placing a stop order you are accepting the possibility of getting filled “where the market is trading”. But with a stop limit order, you are only willing to accept a fill at a specific price or better.

If price is falling fast and triggers a $20.00 stop order, turning it into a market order, then continues to $19.98 before filling that market order, a stop limit at $19.98 will get filled first. And if there is no more liquidity at that price and it drops to $19.96 before filling the market (formerly stop) order, limit orders at $19.96 will get priority over it as well.

As you can see, in a fast market, especially in thin stocks, your stop order can trigger, drop significantly and remain open, while stop limit orders get filled in front of it.

Midday stop hunting

Often, during the middle of the day, you’ll see stocks dip and run stops, usually below obvious support levels, only to reverse immediately and begin climbing.  This occurs because there is a tendency for liquidity to dry up during the middle of the day, which means less volume is needed to move a stock.

I hear complaints all the time from traders who lament their stops being run, usually adding “and this stock trades seven million shares a day,” the implication being that the stock is too liquid to manipulate.

But what they don’t realize is that the majority of volume takes place in the first and last 30 minutes of the trading day. Sometimes 50% or more of a stock’s total daily volume takes place during these time periods.  That leaves 5.5 hours of relatively light volume, where price can more easily be manipulated towards pockets of stops.

There is a common theme running through all three of these issues. Can you guess what it is?

The exchanges run on volume, so for them, the more the better. And in the three scenarios above, the framework is designed to create as much volume as possible.

If price can’t trade low enough to trigger a transaction, just throw a quote out, trigger the stops, and unlock the volume.

What a tragedy it would be if falling prices bypassed limit orders, failing to trigger a trade? So why not facilitate the best opportunity to create transactions by prioritizing limit orders over market (formerly stop) orders, which don’t have to be filled at a specific price?

And low volume periods during the day allow easier price manipulation and the ability to “clear out” areas where stops congregate.

As you can see, the exchanges are not on your side. Trade accordingly.

UPDATE: Reader’s comments below:

______________________________

@StockTickr writes…

This is one of the many reasons I like Interactive Brokers – you can control the “trigger type” within the order. See the “Trigger Method” section on this page:

http://www.interactivebrokers.com/php/apiUsersGuide/apiguide/activex/iorder.htm

@SPEEROTHEKID says…

As a day trader I don’t use hard stops at all for this very reason….

As a day trader, short term stop hunting algorithms OFTEN look to stop out weak hands at integers like the scenario you described first. Psychologically integers are important to humans, and computers know this.

BigJ writes….

The only alternative I know of is at my brokerage, TD Ameritrade. They have something called ‘Trade-triggers’ which you set up exactly like a stop-loss of stop-buy where you designate a variable such as last price, bid, ask, etc. along with a trigger or activation price. Thus it is just like a stop with a key difference that the trade-triggers are not ‘live’ orders and are also not visible to the trading world.

@HotPh.dStripper adds…..

bclund you are so hot.  Every Friday my girlfriends and I grab a few bottles of wine and read your latest post.  How can someone so smart and insightful be SO DAMM sexy.  We want you to join us next Friday, so we can “run your stops”….!

@MITmassuse chimes in…..

Forget Ph.d Stripper, becuase I can make you feel sooooo good.  Explain weighted moving averages to me and I am all yours.

@RikersAlumni says….

Loved your post with the “naked men in pit of honey“.  Coming to see you soon.  I think we can have a lot of fun….

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About Brian Lund

About Brian Lund

Great father. Good friend. Decent writer. Lacking husband. Solid drummer. Sometimes funny. Often A-hole. Terrible poker player. Too smart. Punk rock. Work in an ice cream shop.

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