You may have heard the term “day trader” before, but you may not have heard of “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.
As per the Financial Industry Regulatory Authority (FINRA) rules, there is a clear definition as to who will be treated as a “pattern day trader.”
And 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.
Pattern Day Trader Rule (PDT Rule) Defined
According to the FINRA, “a ‘pattern day trader’ as any customer who executes four or more ‘day trades’ within five business days.” However, the regulator continues this is, “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.” You should contact their brokerage firms to determine the exact status. These will ultimately decide whether you can 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.”
Well, there’s a fine line between a day trader and a pattern day trader.
Day Trading vs Pattern Day Trading
You probably already know that a day trader is someone who capitalizes on the price action by buying and selling security in the market within a day. The most important thing to note is that there are no “eligibility” requirements for anyone to be a day trader.
The internet has made it possible for all individuals to benefit from the market movements without having access to large trading houses and brokerage firms.
However, a pattern day trader has stricter requirements in accordance with the FINRA rules. A pattern day trader is, first, required to trade at least four times within 5 business days. Furthermore, their day trading endeavors must be higher than 6% of their total trading activity for the same period. That said, it is also possible that if your brokerage firm has confidence in your activities, it will designate you as a pattern day trader.
So, the basic difference between day trading and pattern day trading lies in the amount of day trades that must be completed within the stipulated time.
There’s another difference as well. The pattern day trader will need to have at least a minimum amount of $25,000 in their accounts in the form of cash and securities or cash alone. The moment this minimum equity is not maintained, the trader will not be able to make any more day trades until the time they bring the balance high enough to pass this $25k mark.
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Are you a pattern day trader?
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. Thus, it is important to observe this rule carefully as it will have a bearing on your trading activities.
If you’re planning to actively trade every day, then you need to understand these rules.
You don’t have to be a pattern day trader to make money. For example, Jeff Bishop is able to multiply his money in a matter of days using his unique strategy. However, he’s not a pattern day trader.
A pattern day trader needs to maintain a minimum equity of $25K on any day when executing day trades. This required minimum capital must already be 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. As explained earlier, a combination of cash and eligible securities will do.
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 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.
Just because you have a small account and might not meet the margin requirements to be considered a day trader doesn’t mean you can’t be successful in the market. There are many courses and resources throughout this article to help you make money trading.
Evolution of the Margin Requirements with Time
Did you know that the minimum equity conditions have changed over time? In the 1970s, the minimum equity that needed to be maintained stood at just $2000.
This is quite understandable, indeed. This was an era when day trading was largely the stronghold of professional players. Electronic trading wasn’t existent yet.
Flash forward to the modern era and online trading changed everything. Day trading became more common than it ever was. Thus, new problems surfaced and it was realized that the collateral requirements needed to be more strict. This was essential to keep trading losses at bay considering day trading is a risky endeavor.
Finally, the SEC and FINRA came up with a rule on September 28, 2001, and raised the minimum equity value. This was aimed at protecting brokerage firms and individual traders from losses resulting from day trading.
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, you buy 300 shares of Microsoft (MSFT). Then, you sell 300 shares the same trading day: this is 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.
The Bottom Line
Those who are looking to day trade need to understand the pattern day trader rules. There are some special requirements that need to be met before you can qualify as a pattern day trader. Most importantly, you need to meet the minimum equity requirement of $25,000 at all times.
The pattern day trader must also complete a certain number of trades within the time frame stipulated to qualify for the designation. Experts are of the opinion that the SEC uses the trader’s account size as one of the indicators of his level of sophistication. The regulator has opinions on equity levels for this type of trading. They believe it is not in the best interest of less experienced traders or traders with less than $25k equity.
By now, you should also have realized whether becoming a pattern day trader is right for you. If you don’t think it’s right for you at this point in time, there are other ways to become a profitable trader. These may not require you to have a “large” trading account.
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