By Mike Tibbits, YouCanTrade Content Specialist
If you are trading in a small account, chances are you are going to have some unique challenges compared to those trading in a larger account.
The size of your account matters, and not for bragging to your friends or family. Your account size is used to determine the kinds of trades your account is eligible for.
- Accounts under $2,000
If your account is under $2,000, you will not be able to access margin. Margin is kind of like a line of credit that you can borrow from your broker to place trades you wouldn’t be able to afford otherwise. This is a rule set by the Federal Reserve, and all brokers must comply to these rules. Therefore, your trades will be completely funded using your own cash. You will also have to wait through the settlement period. After each closing trade, you will have to wait for those funds to become available again for trading. For stocks, the settlement period is two business days and for options it is one business day.
- Accounts over $2,000 but under $25,000
At this stage, accounts have access to margin, which allows you to use the sales proceeds from your closing trades to immediately place another trade. The challenge at this level is learning how to deal with the Pattern Day Trading (PDT) rule. The PDT rule is another industry-wide rule all brokers must enforce which requires brokers to flag any margin account that completes more than three day trades within a period of five trading days. This rule tends to confuse a lot of people at first, but it’s actually quite simple. A day trade is when you open a position and then close it within the same trading day. So, as long as you don’t close the trade on the same day you opened it, it will not count as a day trade.
Pattern Day Trading Rule
What happens if your account gets flagged under the PDT rule? Well, the rules say that PDT accounts under $25,000 will not be able to place opening trades for 90 days or until the account has a beginning of day balance of $25,000, but individual brokers may include other rules or standards as well. You will only be allowed to close out of any positions you had before you flagged the account.
What about the money in the account? What can you do with it if you can’t open new positions? Well, you have a few options.
- Option 1: You can convert your account from a Margin account to a Cash Account.
Cash accounts are not subject to the PDT rule. This will allow you to continue day trading and open new positions but under the limitation of using your own cash and having to wait through the settlement period after closing trades. After 90 days, you can ask your broker to remove the Pattern Day Trade flag from your account and convert it back to margin if you like. Just remember, you need at least $2,000 in the account to convert it back to margin.
- Option 2: Open a new margin account and start over
Technically, there is no law preventing you from opening another margin account and starting over. You can withdraw the funds from the flagged account and fund a new margin account either with the same broker or a different broker and continue day trading being careful not to flag the newly funded account. Many brokers understand that people aren’t aware of this rule and will allow you to open a second account. However, abusing this option can lead to the broker denying your application, or, worse, they can ask you to withdraw your funds and take your business elsewhere!
- Option 3: Wait the 90 days
I know that doesn’t sound like the solution you wanted to hear, but if you don’t have the funds to bring the account up to $25,000 and neither Option 1 nor Option 2 appeals to you, your only option is to wait the 90 days and ask your broker to remove the Pattern Day Trade flag from your account.
Reduced ability to take losses
Losses happen. Even the best traders have losing trades. What makes a good trader “good” is reducing the probability of taking losses as much as possible. But, when you have a small account, even that isn’t enough. Let’s say your strategy wins 70 percent of your trades on average. Those odds sound pretty good. But, when you are trading in a small account, odds like this still present some rather frustrating challenges.
Imagine your first three trades end up being the other 30 percent – the losing trades. A large account has the benefit of taking the losses and still having money left over to continue playing out the odds. Traders with small accounts face the potential of being wiped out before the odds of the strategy begin to play out in their favor. So, what can you do?
The truth is… there really isn’t much you can do with a small account except to save a little more money and come back with a larger account that can withstand the odds of your trading strategy. Wiping out your account is morally defeating and takes away from your focus. Instead of concentrating on your trades the next time you fund your account, you will be worried about taking losses, which might lead to bad decisions and more losses. Also, depending on how long you take to re-fund the account and start over, the market conditions may have changed, the odds of your strategy may change, etc. Try to save up a little more money before trading so your account can survive through taking losses as they come.
Are you trading a small account and not having success?
You’re not alone… we’ve all been there.
Why not talk about it?
Consider talking to a trading coach! Here at YouCanTrade our coaches know the struggle of growing a small account and are here to listen to your goals and help provide you with the tools to help improve your trading. Watch them live as they trade with real money and ask questions about their trading philosophies. Or, chat with other members of the trading channel.
Join the YouCanTrade community!
You can also join the YouCanTrade community for free and share with other traders who might be in a similar situation.