How to trade in a small account around pattern day trader rule?

Original Question: I’m new to trading and i have a small account. Do you have any recomendation to trade in a margin account around pattern day trader rule? Should i switch my account to cash?

I have only recently started to think about this topic in more detail and it will be covered in a future article.

I never traded a cash account because I didn’t know it existed back when I opened my first account in 2010/11. It is a double edged sword. The problems with trading a small account are manifold. You actually should learn to trade properly from the start but that could mean that it will take you a long time to reach a larger account balance and thus meaningful returns. You also want to get the major sandtraps out of the way early on. Getting them out of the way means to step into them as you won’t be able to dodge them. For me it was a long journey and I recall that I had a lot of trouble to trade up above the 25k barrier back then. It was all psychological.

With my knowledge of today I would approach my early trading years differently. First of all I would start with a cash account for the first year and learn to stick to stops and just trade and watch charts day in and day out. After that I’d switch to a margin account and start to trade with higher risk (~3% of account balance for the stop loss hits) and employ margin to the fullest. When you learn to trade it is helpful to explore the boundaries of your comfort zone and there is nothing wrong with increasing risk to leave the 25k barrier behind you quickly. It also helps if you can show to yourself that you can actually recover from portfolio drawdowns. If you follow such an approach your must realize that you could create deep drawdowns or even blow your account. If that is fine and if you don’t have a hard time saving another stake then this is probably the way which allows you to gather the most experience in a short amount of time so that you are primed to trade properly once you are above 25k. I would also use some part of the portfolio to just buy and hold a big cap growth stock to learn about the market cycles early on.

However if you can’t handle the risk or even trade with money you can’t afford to lose, my advice would be to stick to a cash account and trade only 2-3 stocks at a time with reasonable risk (2 – 2.5% of account balance for the stop loss hits). If you have the base levels of your trading pyramid covered you can hope to create constant profits rather quickly. But you must cope with your urge to “get rich quick” because it won’t be quick. Make sure to focus on your defense as you want to avoid deep drawdowns as the time to recover is long and taxing.

While a cash account would allow me to trade like I do now with all that intraday tweaks you can’t hope to be able to pull this off early on. You simply don’t have the skill yet. So with regards to the pattern day trader rule you just have to apply proper positing sizing and stop loss placement and then mostly trade quiet and tight setups and some momentum gap setups or even the pocket pivots from Gil Morales. Focussing on only two setups will help to keep overtrading in check. Quiet and tight setups can be easily scanned for in advance before the session just like momentum gap setups. And you also want to focus on quality stocks only according to my rules. You enter with a market order at the open and quickly set your stop loss orders. Fire and forget. If you can watch the market intraday you can try to handle them properly with the scale-outs and all that.

In the end it depends on your personality as well. I was a strict robot following CANSLIM rules during my first year. I sticked to my stops but was buying way too late right into ensuing pullbacks. I was eaten alive by my stop loss hits. And then I started to trade recklessly trying to recover. Which I did multiple times. Once I recovered I switched back to my robot self and the bleeding started all over again. Rinse and repeat. It took me a very long time to realize that I only traded fearless and with self awareness when I tried to recover from drawdowns. Over time I learned to merge both personalities into one and got rid of my robot self eventually.


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