Do you actively trade stocks? If so, it's important to know what it means to be a "pattern day trader" (PDT) because there are requirements associated with engaging in pattern day trading. Once you understand the requirements you must meet, you reduce the risk that your firm will place restrictions on your ability to trade.
What Is Day Trading?
Day trading refers to a trading strategy where an individual buys and sells (or sells and buys) the same security in a margin account on the same day in an attempt to profit from small movements in the price of the security. FINRA’s margin rule for day trading applies to day trading in any security, including options.
Day trading in a cash account is prohibited.All securities purchased in the cash account must be paid for in full before they are sold.
Who Is a Pattern Day Trader?
According to FINRA rules, you’re considered a pattern day trader if you execute four or more "day trades" within five business days—provided that the number of day trades represents more than 6 percent of your total trades in the margin account for that same five business day period.
There are two methods of counting day trades. Please contact your brokerage firm for more details on how they count trades to determine if you’re a pattern day trader.
The rules also require your firm to designate you as a pattern day trader if it knows or has a reasonable basis to believe that you’ll engage in pattern day trading. For example, if the firm provided day-trading training to you before opening your account, it could designate you as a pattern day trader.
In general, once your account has been coded as a pattern day trader account, a firm will continue to regard you as a pattern day trader, even if you don’t day trade for a five-day period, because the firm will have a “reasonable belief” that you’re a pattern day trader based on your prior trading activities. If you change your trading strategy to cease your day trading activities, you can contact your firm to discuss the appropriate coding of your account.
What Are the Requirements for Pattern Day Traders?
First, pattern day traders must maintain minimum equity of $25,000 in their margin account on any day that the customer day trades. This required minimum equity, which can be a combination of cash and eligible securities, must be in your account prior to engaging in any day-trading activities. If the account falls below the $25,000 requirement, the pattern day trader won’t be permitted to day trade until the account is restored to the $25,000 minimum equity level.
In addition, pattern day traders cannot trade in excess of their "day-trading buying power," which is generally up to four times the maintenance margin excess as of the close of business of the prior day. Maintenance margin excess is the amount by which the equity in the margin account exceeds the required margin.
What if I Get a Margin Call?
If a pattern day trader exceeds the day-trading buying power limitation, a firm will issue a day-trading margin call, after which the pattern day trader will then have, at most, five business days to deposit funds to meet the call. Until the margin call is met, the account will be restricted to a day-trading buying power of only two times maintenance margin excess based on the customer's daily total trading commitment. If the day-trading margin call is not met by the deadline, the account will be further restricted to trading only on a cash available basis for 90 days or until the call is met.
Any funds used to meet the day-trading minimum equity requirement or to meet a day-trading margin call must remain in the account for two business days following the close of business on any day when the deposit is required. The use of cross-guarantees to meet any day-trading margin requirements is prohibited.
Why Do I Have to Maintain Minimum Equity of $25,000?
Day trading can be extremely risky—both for the day trader and for the brokerage firm that clears the day trader’s transactions. Even if you end the day with no open positions, the trades you made while day trading most likely have not yet settled. The day trading margin requirements provide firms with a cushion to meet any deficiencies in your account resulting from day trading.
Most margin requirements are calculated based on a customer's securities positions at the end of the trading day. A customer who only day trades doesn’t have a security position at the end of the day upon which a margin calculation would otherwise result in a margin call. Nevertheless, the same customer has generated financial risk throughout the day. These rules address this risk by imposing a margin requirement for day trading calculated based on a trader’s largest open position during the day rather than on open positions at the end of the day.
Firms are free to impose a higher equity requirement than the minimum specified in the rules, and many of them do. These higher minimum requirements are often referred to as "house" requirements.
Is Pattern Day Trading Right for You?
Before you come to any conclusion, read and consider the points set forth in the Day-Trading Risk Disclosure Statement embodied in FINRA Rule 2270. In addition to minimum equity requirements, day trading requires knowledge of both securities markets in general and, more specifically, your brokerage firm's business practices, including the operation of the firm's order execution systems and procedures.
Day trading generally isn’t appropriate for someone of limited resources, limited investment or trading experience and low risk tolerance. A day trader should be prepared to lose all of the funds used for day trading. Given the risks, day-trading activities shouldn’t be funded with retirement savings, student loans, second mortgages, emergency funds, assets set aside for purposes such as education or home ownership or funds required to meet living expenses.
I've spent years deeply immersed in the world of trading and finance, keeping up with regulations and market intricacies. The article you shared dives into the complexities of pattern day trading (PDT), a term governed by FINRA rules that significantly impact trading behavior. Let's break it down:
Day Trading:
Day trading involves buying and selling the same security within a single day to capitalize on small price movements. It's exclusive to margin accounts; trading in a cash account is prohibited. In a cash account, securities must be fully paid for before selling.
Pattern Day Trader (PDT):
According to FINRA, you're a PDT if you execute four or more day trades within five business days, provided these trades constitute more than 6 percent of your total trades in a margin account within the same period. Brokers may also label you as a PDT if they have reason to believe you'll engage in such trading.
Requirements for PDTs:
- Minimum Equity: PDTs must maintain at least $25,000 in their margin account on days they engage in day trading.
- Day-Trading Buying Power Limit: This is generally up to four times the maintenance margin excess.
- Margin Calls: Exceeding day-trading buying power leads to a margin call. Failure to meet it restricts trading to a cash-available basis for 90 days or until the call is met.
Why the $25,000 Minimum?
It serves as a safety net for both traders and brokerage firms, covering potential deficiencies resulting from unsettled trades made during the day. Typically, margin requirements consider a customer's securities positions at the end of the trading day, which a day trader might not have due to frequent trading.
Is PDT Right for You?
Day trading demands substantial knowledge of securities markets and brokerage practices. It's not suitable for those with limited resources, trading experience, or low risk tolerance. The risks are high, and funds for day trading should not come from critical financial sources like retirement savings or essential living expenses.
Understanding these nuances is crucial before diving into pattern day trading. The risks are substantial, and it's essential to assess whether it aligns with your financial situation and risk tolerance.
