If you make four or more trades within a five day trading period, you could be considered a PDT, or Pattern Day Trader. This can make you subject to certain rules and regulations that can not only limit your buying power but also make you subject to certain consequences if the regulations are violated. Here are some things you should know about Pattern Day Trading.
You Must Have A Margin Account To Day Trade
In order to be a pattern day trader, you must have a margin account. You will have to sign an agreement with your firm that states you understand you are trading with borrowed money, and that you understand the risks. You may end up having to repay more than what is in your account, and many firms retain the right to sell your own securities if you’re unable to pay what you owe.
You Must Maintain A $25,000 Equity Balance In Your Margin Account
If you place the fourth trade in that five day trading period window, you will be marked as a pattern day trader for up to ninety days. The equity in your margin account must not fall below $25,000.
If it does, you will be subject to a margin call, which will require you to deposit funds in order to meet your requirement. Your trading will be severely restricted or revoked until this margin call is met. Usually, the margin call provides a five day period in which to deposit the funds.
Pattern Day Trading Is Not Risk-Free
Having a larger cushion in your margin account does not necessarily mean that you will incur less risk with your trades. This is simply a standard requirement for day traders that exceed the three trades in the five day trading period.
Your Equity Requirement Must Rest In Your Trading Account
When meeting your equity requirements for pattern day trading, you must have all assets present in your trading account at the start of the trading day.
Funds in an outside bank, firm, or other institution cannot be counted towards the required equity unless they are transferred to your trading account.
This must be done before the start of the trading day, so make sure you make any necessary transfers at least a day before your start trading again.
There Are Day Trading Firms Specifically For This Type Of Trading
While many firms deal in traditional trading options, there are specific firms for day trading that allow you to deposit a certain amount. This amount is usually much less than the required $25,000, and the firm itself provides you with the capital you need to trade. Your deposited capital safeguards the firm from any losses you may take, and you don’t have to have $25,000 in assets to being trading.
You Can Trade With A Cash Account
While using a cash account instead of a margin account means you’ll avoid the PDT rule, it also means that the cash in your account is entirely yours and subject to any losses you may incur. A cash account generally has less buying power on the market than a margin account, and although you can avoid the PDT rules, you’ll be much more limited in your trades by using a cash-only account. Cash accounts aren’t rule-free however, and are subject to separate regulations. Keep your options open, and don’t rule out the advantages of a margin account.
Trades Held Overnight Do Not Count As Day Trading
If you buy 20 shares on Wednesday and do not sell them until the afternoon the following Thursday, this is not considered a day trade, and therefore doesn’t count toward the four or more to label you as a PDT. Some traders will use this method when they’re just starting out and don’t necessarily have the capital to meet the $25,000 equity requirement for day trading.
Day Trading Can Give You 4:1 Leverage
Pattern day traders are able to trade up to four times their maintenance margin excess, whereas normal trading only allows a 2:1 leverage. For example, if a trader has $30,000 worth of equity and does not have a margin loan, the trader can buy up to $120,000 in securities. This gives a significant advantage in that you can purchase four times your margin excess, but it also means greater risk since you’re purchasing more securities.
You and Your Firm Are Subject To The Law
The regulations associated with day trading were enacted in 2001 by the FINRA (Financial Industry Regulatory Authority), which is a non-profit organization that is authorized by the US Congress to protect stock brokers and traders, and ensures the industry operates fairly. These regulations are bound by law, and cannot be violated by either a trader or a brokerage firm without being subject to legal penalties.
Being Flagged As A PDT Account Doesn’t Limit Your Trading Options
If you find yourself labeled as pattern day trader, you can still buy and sell as you would normally. There is more risk in day trading, hence why the label and the subsequent regulations were created. The label simply makes you subject to the regulations and to any penalties for not adhering to them.
You Can Request Your PDT Status Be Removed
You will be flagged as a PDT account when you make four or more trades in a rolling five day period. In order to request this status be removed, you must wait 90 days, and then submit your request to your firm. In the meantime, in order to trade during this period, you’ll have to maintain your minimum equity, and submit to the other regulations of the PDT account.
Pattern Day Trading Is Not “Easier”
While pattern day trading may seem straightforward, maintaining the $25,000 equity may prove more difficult than it seems. You don’t just jump in with some money and start trading. If you want to start training of any kind, it’s important to research and/or acquire training or formal education so as to be prepared when you enter the market.
Going into the stock market unprepared is a good way to incur a significant loss. Finding the right firm for you is equally important. Make sure the firm you choose has a good reputation and fits the type of trading you’re looking to do.
If you have any experience in pattern day trading, leave a comment and share your best advice and recommendation in the section below.
