The Financial Industry Regulatory Authority(FINRA) and the Securities and Exchange Commission(SEC) are tasked with regulating pattern day trading. They do this by requiring brokerage firms to flag pattern day traders and subsequently impose the pattern-day trader rule.
In this article, we take an in-depth look at pattern day trading. The legality, examples of pattern day trading, and the requirements to become a pattern day trader will be covered broadly. What is PDT? We discuss this in the next section.
What is a pattern day trader(PDT)?
The pattern day trader meaning, according to FINRA, is a trader who executes four or more qualifying trades in five business days. The qualifying trader must also meet two other criteria. These are, the trader must use the same margin account for qualifying trades. Secondly, these trades should account for more than six percent of the customer’s total trades in that margin account for that same five business day period.
Day traders may trade in different securities including stocks, equity securities, and shorts sales. Nonetheless, the trades must be opened and closed within the same day. Long and short held overnight are not considered in pattern day trading.
FINRA requires brokerage firms to designate you as a day trader if they observe these patterns in your account. In addition, brokerage firms can designate you as a pattern day trader if they have a reasonable basis to believe you will engage in pattern day trading. When designated as a pattern day trader, there are certain rules and guidelines you must adhere to.
Pattern day trader rule
The pattern day trading rule requires that all pattern day traders must maintain an equity balance minimum of $25,000 in their margin account.
What is a pattern day trader rule?
The Pattern Day Trader (PDT) rule is a regulation that the Security and Exchange Commission (SEC) issues to pattern day traders. The rule requires all pattern traders to maintain a minimum equity of $25,000 in their margin account. The minimum equity can be a combination of cash and any other eligible securities.
When this happens you cannot start your day trades without a minimum of $25,000. This means that you can’t have $24,000 at the beginning and then have your trades bring up your total to the required minimum. Failure to maintain this minimum equity will prompt your firm to issue a margin call that you must address in 5 business days.
History of the pattern day trader rule
During the late 1990s, most traders categorized themselves as day traders. This was largely due to the internet boom and the stock market bubble. The practice grew with many traders admitting to how easy it was to buy stocks and sell within a single day.
As such, a lot of day traders became full-time traders. These novice traders had very little knowledge of the ins and outs of the stock market. Politicians and the media vilified day trading as a result. Consequently, this forced FINRA and SEC to act and hence the pattern day trading rule came to effect on February 2001. This was done under the guise of protecting the investing public.
Example of the pattern day trader rule
The day trading rule applies in such a scenario. So if for instance, Trader A has $1,500 in their margin account they can trade on Tata Motors on Monday, Apple stocks on Tuesday, and Bajaj Finance on Wednesday. After making their three trades within 5 business days, they can not make any other trade until Monday.
Even so, they can only trade on Monday as they have already made two-day trades from Tuesday through to Monday. In case the trader attempts to make a fourth trade before the five-day period has elapsed, the brokerage firm will issue warnings. If Trader A assumes the warnings, the brokerage firm will be forced to freeze the margin account for 3 months.
To enjoy trading more than 3 times, the trader needs to maintain the PDT rule and attain the PDT designation.
What are the requirements for pattern day traders?
To qualify as a day trader you will need to meet the following requirements. For starters, you must conduct four or more day trades within five business days. These qualifying trades must be conducted from the same margin account. In addition, the day trades must account for 6% or more of the trader’s trading activity for the day.
However, the main rule remains that the trades must have a minimum of $25,000 as they start their day trading activity. This simply means traders will have to hold off on trading activities if their balance is less than $25,000 until they can start off with that minimum.
Regulations for pattern day traders
There are certain rules and regulations that must be applied to the trader for pattern day traders. All the regulations that have been put in place must be followed if a trader is to continue trading. Firstly, FINRA requires traders to maintain a daily trading minimum equity of $25,000. If the trader fails to meet the required minimum equity then the firm must issue a margin call.
In the event, the trader doesn’t follow through with the margin call issued, then the brokerage firm is at liberty to take the necessary measures. However, the trader has an allowance of five business days before any cause of action can be taken. In order to meet the margin account minimum brokerage firms impose no withdrawals on deposits until two days have elapsed.
How to remove pattern day trader status
Being a pattern day trader has its benefits and risks altogether. Often, the problem kicks in when you can’t keep up with the minimum of $25,000. The brokerage in most cases freezes your account for a minimum of 90 days.
To prevent this mishap, there is an option to switch to a cash account that allows you to trade freely. In most cases, brokerage firms will have options you can use to remove the day trader status. Some firms make it as easy as clicking on a button and switching accounts.
Pattern day trading FAQ
The concept of pattern day trading has several technicalities that come with it. However, we have enlisted frequently asked questions that will help you navigate your way around this trading strategy.
What is a pattern day trader example?
As mentioned early, for you to be a pattern day trader, you must comply with the pattern day trader rule that requires you to have $25,000 or more in your margin account. Moreover, the same margin account must be used for all the qualifying trades. In this case, when a trader opens a market position in any brokerage firm, they need to ensure that they close their market position within the same day.
If the trader does not manage to buy and sell their stocks within the same day, then that does not account for a successful day trade. Also, the pattern day trader needs to conduct such trades four or more times within five business working days while maintaining their minimum at $25,000 every time they start their day trade.
What happens if I am flagged as a pattern day trader?
Once your firm flags you as a pattern day trader, you must maintain a minimum of $25,000 in order to conduct any day trade. You can combine cash and any other securities deemed fit by your brokerage firm. In case you don’t meet the minimum requirements, FINRA rules require you to hold off on any trading activities until you can boost that amount.
Moreover, once your account fails to maintain the minimum $25,000, the brokerage firm can freeze it for up to 3 months. Nonetheless, the pattern day trader designation allows you to trade more than three times.
Is pattern trading legal?
Pattern day trading is neither illegal nor unethical. In fact, FINRA and SEC regulate pattern day trading thus leaving no room for any unethical practices. However, SEC warns that day trading is a complex trading strategy. For this reason, the commission recommends that only professionals and seasoned traders who understand the stock market should consider undertaking it.
Can I be a pattern day trader?
In order to become a pattern day trader you will need to earn the designation by meeting all the minimum requirements. Additionally, you need a margin account that maintains the pattern day trader rule. You cannot trade using a cash account as it is a violation of good faith. Also, it will always leave you strained for cash. However, even before getting into pattern day trading, ensure you have the required knowledge of the securities market plus your brokerage firm’s business policies. Generally, to become a pattern day trader, you will need enough capital, the required trading experience plus risk tolerance. And You will need simple & repeatable day trading strategies to stay qualified.