Day trading, the practice of buying and selling securities within the same trading day, can be a risky but potentially lucrative strategy. However, it’s crucial to understand the regulations surrounding day trading, particularly the Pattern Day Trader (PDT) rule. This rule imposes restrictions on investors who engage in frequent day trading activities.
Understanding the PDT Rule
The PDT rule applies to margin accounts and IRA limited margin accounts It states that if you make 4 or more day trades within 5 trading days, and the number of day trades represents more than 6% of your total trades in that same 5-day period, your account will be flagged as a pattern day trader.
Consequences of Being Flagged as a PDT
If your account is flagged as a PDT you will be subject to the following restrictions:
- Minimum Equity Requirement: You must maintain a minimum equity of $25,000 in your margin account at all times. This means you cannot trade on margin or borrow money from your broker to purchase securities.
- Day Trading Restrictions: You will be limited to making 3 day trades within a 5-day period. If you exceed this limit, your trades will be rejected, and you may face penalties from your broker.
Avoiding PDT Restrictions
To avoid being flagged as a PDT you can:
- Maintain a minimum equity of $25,000 in your margin account.
- Limit your day trades to 3 or fewer within a 5-day period.
- Consider using a cash account instead of a margin account. Cash accounts do not allow you to borrow money from your broker, so you cannot engage in day trading.
Example Scenario
Let’s consider an example to illustrate the PDT rule:
- You have a margin account with an equity of $10,000.
- On Monday, you make 2 day trades.
- On Tuesday, you make 3 day trades.
- On Wednesday, you make 1 day trade.
- On Thursday, you make 2 day trades.
In this scenario, you have made a total of 8 day trades within a 5-day period. Your day trades represent 80% of your total trades (8 day trades / 10 total trades). Since this percentage exceeds 6%, your account will be flagged as a PDT.
The PDT rule is an important regulation for day traders to understand. By maintaining a minimum equity of $25,000, limiting day trades to 3 or fewer within a 5-day period, or using a cash account, you can avoid being flagged as a PDT and continue to engage in day trading activities.
Frequently Asked Questions
What is the purpose of the PDT rule?
The PDT rule is designed to protect investors from the risks associated with excessive day trading. Day trading can be a highly speculative and risky activity, and the PDT rule helps to ensure that investors have sufficient capital and experience before engaging in such activities.
Can I get an exception to the PDT rule?
In some cases, you may be able to get an exception to the PDT rule. For example, if you are a professional trader or have a substantial net worth, you may be able to apply for an exemption from your broker.
What happens if I violate the PDT rule?
If you violate the PDT rule, your trades may be rejected, and you may face penalties from your broker. Additionally, your account may be restricted from further day trading activities until you meet the minimum equity requirement.
Finding matching buy and sell orders is essential to defining what constitutes a day trade. For illustration, let’s say that at the start of the day, there are no trades in your account. Next, you buy 100 shares to open a new position, or you buy 100 shares to open a 100 share position. Later, you add another 100 shares. You then purchase an additional 100 shares, making a total of 300 shares. You enter an order to sell later that day in order to close those 300 shares. There is only one exit order in spite of the three buy orders. This indicates that there is only one day trade because there is only one pair of matching entry and exit orders.
Use the thinkorswim® trading platform’s Account Info window to help you keep track of your day trades. However, it’s critical to comprehend what occurs if you make more day trades than is permitted. A Day Trade Minimum Equity Call, also known as an Equity Maintenance Call, will be issued to an account with less than $25,000 in equity that has been identified as a pattern day trading account. Although you are not obligated to meet this call for funding right away, your account will be limited to closing transactions only if you make any more day trades while under the call. This implies that you are able to terminate current positions but not create new ones. When you raise the account equity above $25,000 or the PDT flag is lifted from the account, the Equity Maintenance Call comes to an end. You can only remove a pattern day trading flag from your account once. The account will still have the flag on it even if it is later reflagged as PDT.
There are, however, some circumstances in which buy and sell orders placed on the same day might not match and are not considered day trades. This might occur if you’re closing a position that you opened on a prior trading day. Let’s take an example where you already have 100 shares of a stock. When the market opens, you sell to close 100 shares. Later, you decide to buy to open 100 shares. One buy order and one sell order are placed on the same day, but it is not considered a day trade because the first sell order to close was matched with a buy order from the day before, meaning it could not match the buy order placed on the current day.
The pattern day trader (PDT) rule was established by the Financial Industry Regulatory Authority (FINRA) in 2001 with the aim of shielding inexperienced investors from significant losses. Any margin account that executes four or more day trades in a five-market-day period is considered a pattern day trader under the PDT rule. Being flagged brings the account under additional scrutiny, but it’s not always a bad thing. To day trade securities, you must keep a minimum of $25,000 in equity in your account after it is identified as a pattern day trading account.
Make sure using margin aligns with your own investing philosophy before considering a margin loan. It is crucial that you comprehend all of the guidelines and conditions associated with trading securities on margin due to the potential risks. Margin trading increases your level of market risk. Your margin account’s collateral value is not the only thing that can go wrong. To satisfy a margin call, Schwab has the right to start selling any securities in your account without getting in touch with you. Schwab is not obligated to give you prior written notice of any increases it may make to its “house” maintenance margin requirements. On a margin call, you are not entitled to a time extension. Please visit Schwab’s Margin Loans for additional information about margin. 1022-2L2X.
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