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Day
Trading within an IRA – A Money Management Strategy
One of the myths I sometimes hear is people lamenting that they must swing
trade rather than day trade within their retirement account. While this may
sometimes be true when an account value is quite small, on most retirement
accounts it really isn’t the case.
It requires special care to day trade within an IRA. The most critical thing to
keep an eye on are the settlement rules because an IRA is a non-marginable
account and the three day settlement rules apply. This means that funds from a
stock or ETF sold today will not be available for your next trade entry for up
to three business days.
Suggestions within this document will focus on money management to best utilize
your IRA within these settlement rules.
And, of course, since your IRA can not be a margin account, you can not short
stocks. So you are forced to use an inverse ETF to short the market. This fits
well with our trading style so we do not find this an issue at all. Our
preference is to use the Russell 2000 ETFs, TNA for long and TZA for short.
These are great day trade vehicles but be aware that they are miserable
vehicles for holding longer than a few days.
For the purposes of this discussion, let’s assume an account value of $100,000.
This is a figure that is not uncommon in many retirement accounts and makes for
easy discussion because we will be using round numbers.
For stocks and ETFs, a three day period after selling is generally required for
the funds to become available for your next trade. So if you use your entire
account value to enter a day trade and sell before the close, you are done
trading for three business days while the funds “settle”. While this may be
exactly what you want, that one trade had better be a good one.
Our preference is to allow more wiggle room. Some day trades work well and some
do not. We want the ability to move out of a trade without hesitation and without
concern that it will force us to stand idle for the next trade. We also want
the ability to trade an average of ten times per week, so we break our account
into six roughly equal portions. We refer to this as our “One Sixth” rule.
By using one sixth of our account value for each trade, we can therefore
average about six trades every three days, achieving our average of ten trades
per week. This means that some funds will always be unsettled but that
sufficient funds will have settled each night to allow for additional trades
the following day.
In our example, this would allow using about $16,000 per day trade entry. For
purposes of illustration, we’ll also use $45 as an entry price for TNA and $30
for an entry price for TZA.
Simple math reveals that we can make two day trades each day of about 550
shares of TZA and/or 370 shares of TNA and never have to worry about
insufficient settled funds. If your day trade methods are profitable – and
you should never trade within an IRA if your methods are not profitable! –
you should find that these quantities are ample to consistently cover expenses
and build your account value.
Of course, we have oversimplified things here by using averages. There will be
days when the market isn’t moving and it pays to sit out, while there will be
other days that two entries just isn’t enough to keep up with the opportunities.
You’ll have to make adjustments as you go. But the one sixth rule is a pretty
good place to start for someone who wishes to day trade within an IRA.
Good trading!
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