The "$5 Rule" Gives You a Powerful Edge over Goldman Traders

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We hear it all the time, this notion that professional traders at top-tier Wall Street firms like Goldman Sachs, JPMorgan Chase, and HSBC have tremendous advantages over smaller, individual investors.

The system is rigged…

Too-big-to-failbankers are getting richer at the expense of the little guy

And a lot of it's true. We reveal these "insider advantages" all the time here at Money Morning.

But as a former hedge fund trader at Goldman Sachs, I know firsthand that some of these notions are fantasy.

In some cases, operating outside the system gives you the edge, especially when it comes to "The $5 Rule."

It handcuffed me at Goldman, essentially forbidding me to make an irresistible trade. But it didn't ban my non-Goldman friend from the opportunity. So he made the trade.

And it worked.

He turned $50,000 into more than $1 million, in less than two years.

Clearly, this is an edge the big-gun institutional traders wish they had…

The Freedom to Make Money… Any Way You Want

At most major Wall Street firms, there are trading and operational policies in place that restrict and limit employees from engaging in the kind of trading that an individual not employed at the firm is free to pursue.

These personal-account trading rules can be highly restrictive.

While I was at Goldman Sachs, there were rules preventing short-term trading in employee accounts. In many cases, employees were forced to hold positions for anywhere from three to six months, depending on the type of security traded.

Normally, this wasn't a big problem. But it became a huge problem back in 2000, right as the tech-stock bubble was bursting. Many of my fellow employees owned big personal positions in some of the most speculative tech stocks out there. Yet due to the trading restrictions imposed by the firm, they were prohibited from selling positions right as they were falling off the proverbial cliff.

Of course, individual investors don't have this problem. If you want to sell, you just press a few buttons, or call your broker, and you're out. Case closed.

You also have an advantage on the buying side…

The "$5 Rule" Gives You a $1 Million Edge

Another restriction imposed at Goldman Sachs was a rule prohibiting employees from buying stocks that traded under $5.

Now, I'm not usually an advocate of stocks that trade under $5. But, as with just about everything in life, there is a proper time and place for their use.

During runaway bull market moves, such as what took place in 1999 and again in 2009, these low-priced stocks tend to outperform due in large part to the fact that they have the highest beta, and the biggest potential for price swings to the upside. For instance, it is a lot easier for a $1 stock to triple in value to a $3, than a $100 stock to triple to a $300 stock.

In 1998, right before the big 1999 tech bull run, a friend of mine identified a dot-com stock trading under $1 – a company he believed had fantastic upside potential.

After checking the company out, I agreed with him. But there was nothing I could do about it. I was barred from owning this stock due to the sub-$5 per share rule.

My friend, however, worked at a currency trading firm that imposed no stock trading restrictions on its employees.

His "freedom" paid off.

The stock eventually soared, shooting above $20 by 2000, allowing my friend to turn his $50,000 investment into over $1 million. Wisely, he sold his position, took his trading profits out of the market, and redeployed that capital into real estate – right before the boom in that market got underway.

Years later, after I had left Goldman Sachs and had ventured out on my own, I was finally able to make some big money in low-priced stocks.

There's no doubt it was a great experience to have spent years as a trader at a money-machine like Goldman Sachs. But savvy individual investors operating without restrictions can actually do better than the pros.

Remain both bold and nimble… and you can do a lot better.

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  1. Robert E Poulson | December 29, 2013

    It appears that Money Morning has the potential to get my investments moving!

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