For answers, please read on.
What is a PDT?
Generally, the phrase PDT (Pattern Day Trader) refers to investors or traders trading using margin accounts. Instead of using their cash, these traders use the broker’s money which is usually deposited in the margin accounts.
These accounts and the financial assets purchased through them are used as collateral. And the trader has to pay a periodic interest rate to keep the account active. These accounts let investors increase their trading and purchasing power.
Trading using these accounts is using leverage to magnify your returns or losses. Unfortunately, these accounts come with a number of restrictions that the trader has to follow, and this is on top of the periodic interest rate.
What is the PDT Rule?
PDT rule applies to clients who execute over four day trades in 5 business days using a margin account. These trades must constitute over 6% of the account’s total trade activity in the five business day window.
This rule came into effect in 2001 as a means of lowering the risk associated with day trading. And the broker can designate your account PDT if you exceed this rule. But does pattern day trading apply to cash accounts?
Does PDT apply to cash accounts?
No, this rule doesn’t apply to day trade in cash account; therefore, you can maintain any amount of cash in your account. Unfortunately, this leaves the no PDT accounts at a disadvantage, especially when the market is going their way.
The PDTs can trade in a wide range of securities, like short sales and stock options. In fact, every trade will count as long it occurs in a single day.
Fortunately, the PDT accounts have more Purchasing power than the cash account for day trading. Basically, this means that they use more than the average day trading purchasing power.
The purchasing power of a PDT account is 4:1, while that of a cash account no pdt rule is 2:1. This means that a PDT account with $50,000 gets up to $200,000 to trade in a day.
Unfortunately, you can only hold these trades during the day since you can’t hold positions at night. But with your own cash, you can place several trades. The downside and one of the most annoying cash account trading rules are that you have to wait for your money to be free to use again.
A cash account pattern day trader has to wait for up to days for the cash to be accessible for more trades. Even the holders of the cash account tastyworks cannot enjoy the margin benefits.
The downside to the PDT accounts is that if you break the rules, there will be a margin call. With a margin call, you have five days to respond. On top of that, your account will be restricted to 2:1 until when the call is met.
Failure to answer can result in a cash restriction account status until when you’ll resolve the issue.
Example of Pattern Day Trading
If the financial assets in your margin accounts is worth $100,000, then you need at least 25% of this amount in equity. But if your equity exceeds your maintenance margin by a certain amount (for instance, by $10,000) then you’re at an advantage.
The rule stipulates that they can buy up to 4 times the excess maintenance margin or $40,000 in stock. This is twice the amount a typical day trader can purchase, which is usually two times ($20,000). The ability to acquire more increases the likelihood of doubling your ROI.
But, like with most trades, this also means that your losses can be even more significant. Therefore, the PDTs have to trade carefully since their risk is higher.