What you need to know to be a pattern day trader

Jason BondJason Bond ·

You may have heard the term “day trader” before, but you might not have heard “pattern day trader.” Well, they’re essentially the same. However, when you’re trying to get into day trading you need to know the specifics. Due to the Financial Industry Regulatory Authority (FINRA) rules, there is a clear definition of who a “pattern day trader” is. That in mind, you’ll need $25K to day trade. Now, if you don’t know the intricacies of these rules, you could potentially find your account frozen one day. That said, here’s what you need to know to be a pattern day trader.

What you need to know to be a pattern day trader

Pattern Day Trader Rule Defined

FINRA definition states, “A ‘pattern day trader’ 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.  This rule represents a minimum requirement, and some broker-dealers use a slightly broader definition in determining whether a customer qualifies as a “pattern day trader.”  Customers should contact their brokerage firms to determine whether their trading activities will cause them to be designated as pattern day traders.

Moreover, the SEC notes, “Under FINRA rules, customers who are deemed “pattern day traders” must have at least $25,000 in their accounts and can only trade in margin accounts.”

What’s this all mean if you want to get into day trading and be successful at it?

Well, there’s a fine line between who is considered a pattern day trader.

Are you a pattern day trader?

Basically, if you buy and sell or sell short then cover the same security during the same trading day, that’s considered a day trade. If you do this four or more times in five business days, if the number of day trades is more than 6% of your total trading activity for the same five business days, you’re considered a pattern day trader.

However, if you execute say three day trades in five business days, you’re not considered a pattern day trader. That said, you would not be subject to the $25K requirement.

If you’re planning to actively trade every day, then you need to understand these rules.

Margin Requirements

A pattern day trader needs to maintain minimum equity of $25K on any day when you execute day trades. This required minimum capital must be already in your account before you execute any day trades. But what happens if you take a few losses and your equity falls below $25K? Well, you would not be able to “day trade” until you replenish your account and maintain the $25K minimum equity. You don’t necessarily need to replenish your account, you could use a combination of cash and eligible securities.

Pattern day traders who exceed the day-trading buying power limits would receive a day-trading margin call. Then, they would only have five business days to deposit funds to meet the margin call. If the margin call is not met, the account would be restricted to only two times the maintenance margin excess. Now, if it’s not met by the fifth business day, these pattern day traders would be restricted to trading only on a cash available basis for 90 days or until they meet the margin call.

Examples of Day Trades

Let’s take a look at some examples so you’re more familiar with the pattern day trader rule. For example, if you buy 300 shares of Microsoft (MSFT). Then, you sell 300 shares the same trading day, it’s considered a day trade. If you do this another 3 times within five business days, FINRA considers you as a pattern day trader.

Now, what if you bought 300 shares of MSFT and did not sell until the next trading day? This would not be considered a day trade. If you have a small account or do not want to open an account with over $25K, you could look to other potentially profitable trading styles.

The Bottomline

Those who are looking to day trade need to understand how the pattern day trader rules. By now, you should know whether becoming a pattern day trader is for you. However, even if you don’t think it’s not right for you, there are other ways to become a profitable trader, and it may not require to have a “large” trading account.

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Jason Bond runs JasonBondPicks.com and is a swing trader of small-cap stocks.

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