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How You Can Overcome The PDT Rule and The Stock Trading Strategy You Should Be Choosing

 

So, you want to be a day trader? That sounds like a great idea, but you definitely need to have a strong understanding of the rules and regulations that apply to day trading. Small traders might find the Pattern Day Trader rule (PDT rule) to be a major restriction when trading.

So, what can be done about it? This is exactly what this article will show you. We will see some different stock trading strategies, and discuss the merits of each to help you decide which route you should take.

What Is a Day Trade and How Does Day Trading Work?

Before getting into the PDT rule, let’s talk about day trading. A day trader uses price movements of a stock within the day for both long and short trades. They close their trades before the trading day ends, and don’t keep their positions open overnight. They typically work by examining stock prices and entering and exiting at a rapid pace to earn small profits along the way which can quickly add up. If a day trader purchases a security and doesn’t sell it later that same day, that isn’t classified as a day trade.

As you can guess, there are no statutory requirements for someone to be called a day trader. It all depends on the number of times you trade, or the trading duration.

As you can guess, there are no statutory requirements for someone to be called a day trader. It all depends on the number of times you trade, or the trading duration.

What tools does the day trader use?

A day trader spends a lot of time using technical analysis techniques every day. They’re exceptionally good with technical analysis, and have an inherent ability to manage stress well.

Day traders are mainly into analyzing price action — the movement of the stock price as a function of time. Since there’s a lot happening by the minute, the day trader has to stay on top of the trends as stock price varies. They can do this through various platforms.

What Is FINRA?

FINRA is the Financial Industry Regulatory Authority. It’s a not-for-profit, government-authorized organization that oversees all U.S. brokers. Their work is to ensure a fair financial market and protect investors. FINRA oversees more than 600,000 brokers across the United States, using artificial intelligence technologies to keep a close eye on the market.

Pattern Day Trading and the PDT Rule

Though similar, there is a difference between a day trader and a pattern day trader. A pattern day trader is a designation given to traders who day trade at least four or more times during a period of five business days. Their day-trading activities must also exceed 6% of their total trading activity for this same five-day period. If you don’t meet this requirement, the brokerage firm you are associated with can recognize you as a day trader.

Thus, a pattern day trader is a day trader with an additional requirement on the number of day trades that must be met to qualify. This is where the PDT rule comes in. Implemented in 2001, the PDT rule helps reduce day trading risks. Here’s an in-depth look at the rule:

  • Once a day trader is deemed a pattern day trader, the FINRA requires them to have a minimum amount of $25,000 in their brokerage account at all times. This is where trading activity occurs. It’s not essential for the entire $25K to be solely in cash as a combination of cash and eligible securities is also acceptable. This requirement helps reduce the risks that are inevitably linked with day trading. Having an account like this also gives you more buying power.
  • FINRA clearly states that this is the minimum equity that must be maintained before day-trading activities can commence.
  • The moment the equity falls below the $25,000 mark, the pattern day trader will have to abstain from any day trades until the time the account has sufficient balance.
  • Brokers usually lock the account of the day trader as soon as the PDT rule is violated. Each broker has its own lockout period which could last from 1 to 4 months.

The PDT rule was initiated for protecting the interests of new traders who could easily mess things up if they aren’t careful enough. Prior to this, there wasn’t a rule to protect inexperienced traders in the day trading space.

The PDT rule was initiated for protecting the interests of new traders who could easily mess things up if they aren’t careful enough.

This equity requirement can make things complicated for small traders who do not have an account with $25,000. Such traders can only undertake 3 or fewer day trades in a 5-day period.

Read our page on technical analysis tools such as Bollinger Bands which has remarkable insights that you can use when trading.

Consequences of Violating the PDT Rule

If you’re in violation of the PDT rule, there are some consequences you may have to face. The consequences you receive will ultimately come down to your broker. If this is the first time you’re in violation of the rule, your broker may go easy on you. Regardless, you’ll probably be flagged as a pattern day trader so your broker can supervise your future activities.

In other cases, you may have a minimum equity call, which means you have to deposit enough money into your account to get it back up to $25,000. Until you do, you probably won’t be able to trade for 90 days. Other consequences may include you having to close out your positions or it may involve the suspension of your margin buying power.

How to Get Around the PDT Rule

Getting around the PDT rule legally isn’t as difficult as you might think, especially if you know the right strategies. Here are some workaround methods:

  • Restrict the number of day trades. This automatically disqualifies you from the PDT rule.
  • Open multiple accounts with different brokers. You can then undertake multiple day trades within a 5-day period. In addition, each account gives you another three-day trader per five-day period. With this option, you can open any number of $100 accounts with different major brokers. However, there’s a catch — you need to arrange to file your taxes accordingly if you have multiple accounts. Even though this technique is perfectly legal, you might have to put more time into tax preparations.
  • Consider swing trading. Swing trading involves maintaining your position for a time frame spanning more than a day. The holding period can last from a few days to weeks. This is not only a way to avoid the PDT rule, but will also keep the stresses associated with day trading at bay, and may be a more lucrative option to consider. This is not to say that swing trading is less risky, though!
  • Join a proprietary trading firm. Three types of these firms include leverage stores, a mentor-based firm, and professional firms. Leverage stores extend you more leverage. Mentor-based firms want people who are passionate about trading and they require savings or other income. Professional firms, on the other hand, hire people with advanced degrees and tend to pay a salary along with a profit split. Joining a proprietary trading firm is best for undercapitalized traders who are invested in trading.
  • Choose a foreign broker. Many foreign markets have less strict minimum equity requirements than the US.
  • Use a cash account.Though this helps you avoid the PDT rule, it’s important to know that day trading in a cash account is typically prohibited. A way to get around this is to ensure that the Regulation T of the Federal Reserve Board, particularly the free-riding prohibition, is not violated by the traders, in which case day trading using a cash account is permissible.
  • Trade in a different market. Consider the forex and options market, for example. The capital requirements of many markets could be significantly lower.

While each of these approaches can help you determine the best method for trading without the PDT rule, they come with their share of pros and cons. I’d like to draw your attention to the suggestion of swing trading, in particular, and other trading styles to get around this rule. In the next section, we will explore these trading styles in more detail.

Worried About the PDT Rule? Consider This Trading Strategy

We discussed how swing trading is a great way to bypass the PDT rule in the previous section. Swing trading is a strategy in which a trader will hold onto an asset for typically several days. The idea is to make profits when the price moves favorably.

Swing trading is a strategy in which a trader will hold onto an asset for typically several days.

As you can see, a swing trader holds his assets for a longer time frame compared to the day trader. However, unlike an investment strategy that buys and holds for several months or even years, swing trading does so for months at the maximum.

Swing Trading and Penny Stocks

You should also consider swing trading penny stocks, which are cheap and hold interesting possibilities. Penny stocks operate in volatile conditions, which opens a whole new world of opportunities for swing traders who can realize massive profits in a short interval of time.

Penny stocks are usually considered to be those that are valued at or below $5. This lets you buy a lot of stock at low prices. These are typically issued by small companies and can be very promising indeed. Of course, penny stocks carry risks since there is a degree of speculation involved. Look out for penny stocks that have good volume, and fewer outstanding shares.

If you are a new trader exploring swing trading, then penny stocks might just be a perfect choice. They’re also a great way to make profits without being bound by the PDT rule.

Final Words

The PDT rule requires qualifying day traders to maintain minimum equity of $25,000 to be able to make more than four trades in a five-day period. However, many small traders, especially those just starting out, might find their trading activities being limited as a result of this rule.

There are several ways to bypass the PDT rule, as I pointed out above, and you should consider swing trading as a great alternative to make profits. Offshore brokers might also be worth considering. A simple way that does not involve any complexities is to limit the number of trades.

Whichever option you go with, check out the RagingBull page on technical analysis tools which shows you how you can use these tools when creating a profitable trading strategy. Technical analysis is a powerful skill that every trader – beginner or professional – should master.