The PDT rule is applicable to all those pattern day traders who have a margin account

When it comes to day trading, there are several different rules that you should be aware of, irrespective of whether you are trading futures, forex, stocks, cryptocurrency, or options. Those traders that do not adhere to them could face large financial implications. In order to stay in the black, you need to pay close attention to these, in particularly the Pattern Day Trader rule.

Introduced by the United States Financial Industry Regulation Authority, the PDT rule is applicable to all those pattern day traders that have a margin account. But what exactly is a pattern day trader? I hear you cry.

In order to be considered a pattern day trader you must make four or more day trades over a period of five working days consecutively. This is only true if those trades make up more than 6 per cent of your total trades during that five day period. OK, but what is a day trade?

For a trade to be classed as a day trade, it must consist of two separate buying and selling transactions on the same asset during the course of a single day. These transactions are required to offset one another in order to be recognized as a day trade, according to the Pattern Day Trader rule. Holding a position over night on an asset is not considered a day trade.

Now you know what a pattern day trader is and what constitutes a day trade, let us take a close look at the Pattern Day Trader rule.

What are the rules?

For any traders that meet the requirements and are, therefore, classed as a pattern day trader, there are a number of specific rules that they must follow. These include:

• Having a minimum balance in their account – The most restricting rule to follow is that which requires a trader to have a minimum of $25,000 in their brokerage account. If the amount in your account goes below this at any point then your buying power will be severely restricted. This amount cannot be met using cross guaranteed accounts. But it can be met using a combination of both eligible securities and cash. The equity must remain in your brokerage account for a minimum of two working days without a withdrawal.
• Meeting sales conditions – Selling a position that you already hold from a previous day’s trading, and any repurchase there after is not classed as a day trade.
• Not exceeding their buying limit – The buying power of a pattern day trader is four times greater than the close of business excess of the New York Stock Exchange. Calculating day trading using the time and tick method is acceptable. If this limitation is exceeded then you will be issued with a margin call.
• Meeting margin calls – Once a margin call has been issued, the buying power of a trader is reduced to just two times greater than the close of business excess of the New York Stock Exchange. Additionally, the time and tick method cannot be used to calculate day trading. Alternatively, the aggregate method (the total of every day trade made) is used. If you do not meet the margin call with five working days, then your power to buy assets will be reduced even further. This stays in place for ninety days, or until you meet the margin call.

Despite these very strict rules and regulations, there is an advantage to it all, and this is the ability to acquire leverage. Those traders that are not considered pattern day traders can only have positions that have a value of twice that of their entire account balance. However, as a pattern day trader you are allowed as much as double the standard margin on stocks.

This level of power when it comes to buying is worked out at the start of each day’s trading and can vastly increase a traders profit potential. However, this can also work to make losses even more significant if things take a downward turn. It means that a trader can potentially lose a greater amount than they initially invested. If you are unable to quickly subsidize this, then the brokerage firm that you have an account with is allowed to and may liquidate you.

If this same brokerage firm gave you any form of trading relating to day trading prior to you opening your account with them, then they will probably automatically class you as a day trader regardless of your actual trading strategy. This means that even those that are new and inexperienced may be classed as day traders, and so will need a large amount of initial equity to get started.

Similarly, once you have been classed as a day trader, the label will still stick even if you do not trade for a consecutive period of five working days. This is because the brokerage firm will still believe that you are a pattern day trader as a result of your previous trading activities. You should always contact your broker should your trading strategies change, so that the Pattern Day Trader rules are lifted from your account.

Those traders with a cash account, opposed to a margin account, are unable to perform pattern day trading to a certain extent. The only way in which they can trade is by not violating the Federal Reserve Board’s free riding prohibitions as set out in Regulation T. This means you must always pay for any asset you hold prior to selling it. If the prohibitions are broken then the brokerage firm will freeze your account for ninety days.

It is important to note that the rules and regulations relating to day trading depend upon where you trade, how you trade, and what assets you trade. Although it may seem like a mundane activity, it is a worthwhile activity to do some research as to what rules apply. In the long run it will be worth your while as it may mean you could avoid making costly breaches. For more details check out timothysykes.com/blog/pattern-day-trader-rule.

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