A subject that doesn’t get the attention it deserves is pattern day trading. The worst part about the subject being overlooked is the amount of trouble it can get you if you aren’t ready for the requirements.To help you get a more in-depth understanding of pattern day trading, we are going to break down the subject bit by bit. We will start by explaining what a pattern day trader is, and the PDT Rule associated with pattern day traders.
What is a Pattern Day Trader?
Believe it or not, there is a direct definition for a Pattern Day Trader. According to FINRA rules, a pattern day trader is defined as, “any customer who executes four or more ‘day trades’ within five business days, provided that the number of day trades represents more than six percent of the customer’s total trades in the margin account for that same five business day period.”
In short, the PDT rule is:
4 or more trades in 5 business days exceeding 6% of margin account = day trader
There are a few very specific phrases in this statement that you need to pay attention to. The first being the specification of the account type. Pattern day trader rules only apply to margin accounts. That means that people purchasing on credit can be affected by these trading rules, but a cash account will not. If you are using a cash account in tandem with a margin account, these rules could apply if you meet the PDT threshold.
Pattern Day Trading Requirements
Should you break the trading threshold and be labeled a pattern day trader, there are a few things you need to know. First off, being a pattern day trader isn’t always a bad thing, especially if you already have the money to meet the floor. The financial floor we are talking about is the required $25,000 of equity in your brokerage account. This financial floor is used as a baseline for your securities, but you cannot fall below the $25k without risk of freezing your accounts. Once again, if you are operating with a cash account, this threshold will not apply to you.
It’s important to note that your gains or losses with pattern day trades must exceed 6% of your accounts equity. That means if you make a pattern day trade that profits $1500 or more on your $25k account, that deal will be subject to your pattern day trade tally.
The other part of this is the trading deadline requirement. To be classified as a pattern day trader, your buying and selling, or short selling and rebuying, needs to take place in the same business day. That means if you buy in the morning and sell before the day’s close, that counts as a pattern day trade. If you do this more than 4 times in a 5 day period, you can expect your margin account to fall under pattern day trader rules, so you better be ready with your $25k.
An example of this is someone purchasing 50 shares of apple at 10 AM, 50 more at 12 PM and selling all 100 at 4 PM. This person has completed two-day trades with their margin account. If they do two more day trades in the next 4 days, they will be subject to PDT.
How Can You Avoid Being Classified Under PDT Rules?
We will start right where we left off with the counterexample. If someone purchases 100 apple stock during Tuesday’s business day, they are not subject to a pattern day trade mark if they sell if during the next business day. So, to avoid marking yourself for PDT, you can wait until the next business day to avoid penalty.
Another way to avoid being subject to PDT regulations is by operating with a cash account. If you aren’t pushing around credit to make moves, your account opens possibilities to day trades. Since your equity is direct cash, falling below the $25k threshold won’t put your account at risk of freezing. Unlike a margin account, a cash account won’t be frozen until you replace the money lost on your threshold.
If you are looking to avoid these requirements for pattern day trading all together with a margin account, try extending your trading periods or staying below the four transaction limit. You can do 3 pattern day trades in 5 days without triggering the required $25k minimum. You can also look for health week or month long buy-ins.
What Happens When You Are Classified As A Pattern Day Trader?
Should you fall under the classification of being a Pattern Day Trader, there are a few things you should be aware of. First off, you need to pay mind to closing restrictions. If you close a deal as a PDT on the same day, you will have to wait a few days before you can access the physical funds. Think of it like depositing a check at the ATM. It might not be available right away, especially if you are cashing it after the branch is closed.
Keep in mind that you can still use these funds even though you have to wait for them to clear. It all comes down to what is in the margin account at the time for equity. If you are still above your threshold, you can use the money in utero to buy or option, at your own risk. The requirement to wait is placed on money you plan to pull from the account.
The Short and Skinny on the PDT Rule
All in all, you should really try to avoid the pattern day trader rule if you don’t want to tie up a minimum of $25k in your account. That’s money stuck in equity you can’t touch, and therefore, it’s not being to use making you money. If you widen the timeline of your investment opportunities to weeks or even a few days, it’s pretty easy to avoid the label. You can make your trades as normal without really worrying about it if your timelines are even longer. With that being said, you really need to keep this rule in mind.
Should you choose to simply forget this rule, a market crash could spell the end of days for your investments if you aren’t moving with the market carefully. That one little slip up could see your margin accounts frozen until you replace what you owe your broker. Sounds fun right? Yeah, we didn’t think so. If you do end up in the red, just expect your brokerage firm to send you through some PDT classes before they help you invest again. You know, once you have gotten back up to that $25k minimum your account requires.