If you are actively day trading you have more than likely come across the pattern day trading rule. You may have even received a notification from your broker that you have violated the rule and are confused as to why. It’s a very common occurrence and it’s important to understand the rule if you plan on day trading or actively managing your investments. Let’s take a look at how the pattern day trading rule works and how to work around it if you don’t have the minimum capital required to day trade.
- A pattern day trader is a trader who executes 4 or more day trades over 5 day trading days on a margin account, cash accounts are not subject to the rule
- PTD rule states that a pattern day trader must maintain minimum equity of $25,000
- The PTD rule is limited to equities and equity options, other products like futures, commodities, and forex are excluded
What is Considered a Pattern Day Trader (PDT)
A pattern day trader (PTD) is an individual trader or investor that executes four or more day trades over five trading days on a margin account. According to FINRA, under the PTD rule, a pattern day trader must maintain minimum equity of $25,000 on any day the customer day trades.
The required minimum equity must be in the customer’s account before any day-trading activities. If the client’s account falls below the $25,000 equity requirement, the trader will not be permitted to day trade until the account is brought back up to the $25,000 minimum equity level.
Important Note: It’s important to make the distinction that pattern day trading applies to margin accounts only and not cash accounts. This is something that is commonly misunderstood by most day traders.
What is Classified as a Day Trade?
A day trade is classified as buying and selling or selling short then buying the same security on the same day. The keyword being here, the same day. If you just purchase stock in a company and don’t sell it, this isn’t considered a day trade. It has to be a combination of the two below:
- Buying + Selling on the same day
- Selling Short + Covering the trade the same day
Understanding the Pattern Day Trader Rule
The main reason behind the PTD rule is to require that certain levels of equity be deposited and maintained in day-trading margin accounts. As stated by FINRA, the equity levels need to be sufficient to support the risks associated with day trading activities. It’s also in place as a safeguard to keep smaller investors from overtrading.
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Under the pattern day trading rule, traders can trade up to four times the maintenance margin excess in the account as of the close of business on the previous trading day. If a trade exceeds the day-trading buying power with the brokerage, the trade will receive a margin call.
Once a trader receives a margin call, they will have five business days to deposit funds to meet the day trading margin call. If the trader fails to meet the necessary margin call by the fifth business day, the account will be restricted to trading only on the available cash amount for up to 90 days or until the margin call is met.
Important Note: The PTD rule is limited to equities and equity options. Futures, commodities, and forex and not included.
PDT Rule Cash Account
Most day traders aren’t even aware of the fact that the PTD rule only applies to margin accounts. In a cash account, you can make as many day trades as you want. The only stipulation here is that you need to be trading with settled cash funds.
The main reason that margin accounts are the go-to account type for day trading is due to the SEC’s cash settlement rules. The SEC’s cash settlement rule states that transactions must “settle” within 2 business days of their trade. This is commonly known as T+2 settlement.
For example, if you sell your shares of Microsoft on Tuesday, the transaction would settle on Thursday. This means that you can’t use those funds to trade for two days AFTER the transaction date. Cash accounts can be a great option for traders who want to have the ability to day trade and are okay with using their settled cash to do so.
Pattern Day Trading Loopholes
There are ways in which you can get around the pattern day trading rule with some limitations. It’s hard to completely get around it unless you have $25,000 minimum equity. As we have discussed, one of the ways is to simply open up a cash account. But as we have discussed that comes with its own set of limitations and challenges.
Below are some other options to consider:
Open Up Multiple Brokerage Accounts
Opening up multiple brokerage accounts will give you some leeway around the pattern day trading rule. If you have 2 brokerage accounts, for example, you’ll be able to perform 4-day trades at one broker and 4 at another. This doesn’t completely get you around the PTD rule, but it gives you some additional trades that you can execute.
Use an Off-Shore Broker
There are stockbrokers not domiciled in the United States, who don’t have the same regulatory restrictions on day trading. As a result, they can allow you to get around the PTD rule and other securities regulations.
It’s worth noting that you should carefully research off-shore brokers if you plan to go this route. Off-shore brokers can have higher trading fees and other platform-related fees that may make it hard for you to be as profitable.
Trade Different Instruments
If you want to perform day trades without any sort of PTD rule restrictions, trading instruments that don’t have this restriction are an alternative way that some traders chose. Below are financial instruments that aren’t subject to the PTD rule.
- Synthetic Indices
What happens if you break the pattern day trader rule?
If you happen to break the pattern day trading rule, your trading account will get flagged. You could be subject to a margin call, and then you will have 5 business days to meet the margin call. Most brokers will usually give you a warning the first time it happens. If you break it a second time, you may be subject to a 180 day-trading ban. This will all vary on your broker.
How long are you flagged as a pattern day trader?
If you break the PTD rule your account will be flagged as a pattern day trader for 90 calendar days. It’s recommended that you check how your broker handles pattern day traders as some are slightly different.
How many trades can a pattern day trader make?
The rule permits you to make up to four trades (open + close) in a five-day rolling period. Buying and selling a security on the same day is classified as a day trade.
Should I be concerned that I’ve been flagged as a pattern day trader?
Getting flagged as a pattern day trader is not necessarily a negative. You will simply face certain trading restrictions as a result and it’s for a temporary period of time. If your account equity falls below the $25,000 minimum, a pattern day trader will not be able to trade until the account is brought above the $25,000 minimum.
How do I get rid of pattern day trader status?
There are a few ways to get rid of your pattern day trader status. You can simply contact your broker and request that they remove your pattern day trading designation. Most brokers will be able to remove for you as long as you don’t engage in day trading. Secondly, you can open a cash account and not engage in day trading.
If you are account is flagged as a PTD by mistake, contact your broker and they will remove your designation.