Pattern Day Trader (PDT) rule is simply a description from the Securities and the Exchange Commission (SEC) that is usually given to traders who tend to make four or more day trades in their margin account over a five (5) day business period. The number of trades must constitute more than 6% of the margin accounts total trade activity during that five-day window.
When this occurs, the traders account will be flagged as a PDT by their broker, the PDT would then place certain restrictions on further trading, this helps to prevent excessive trading by the investors and was implemented in 2001 as a safety feature as a means to help reduce the risk associated with day trading.
What is a Day trade?
A day trade happens when you purchase or short a security and then sell or cover the same security in the same day. If a security is purchased without selling it that same day, it would not be considered a day trade.
Example of day trade.
- Investor starts the day with zero shares
- They buy about 100 shares of ABC when the market opens
- An hour later, they sell the 100 shares of ABC to close the position.
Understanding Pattern Day Traders (PDT)
There are different types of securities that pattern day traders trade with, this includes stock options and short sales. Any form of this trade will be accounted for, in terms of designation as far as they occur on the same day.
If you are flagged as a pattern day trader, you will face certain account restrictions or some requirements. According to the FINRA rules, when a customer has been marked as a pattern day trader, they must have at least $25,000 in the accounts and can only trade in margin accounts, if it falls below, the pattern day trader will not be allowed to trade until the account is restored to the required figure.
Once you are flagged by your broker as a pattern day trader, you will still be regarded as a pattern day trader even if you do not trade for a while, because they would believe based on your previous activities, the pattern would be the same. But you should discuss with your firm, if you have decided to reduce or change your trading activities, so the account can be coded.
Getting around PDT in 2021
- Opening multiple brokerage accounts: you can spread your capital around different brokerage accounts and be able to get three trades on each of them daily and if any is flagged by the PDT designation, you would have backup accounts with a cash setup. The only drawback would be the spreading of thin capital, but it won’t matter if you are trading highly volatile low float stocks.
- Changing trade style: it can be stressful to change trading style due to the PDT rule. This becomes more of an advantage if you trade large-cap stocks, because they do not move around a lot. Although they are risked involved, but you could always make a few days trade a week on low floats then let the professionals handle it from there, they understand the market dynamics better.
New traders tend to find the PDT rule as a thorn in their flesh. If a new day trader was able to day-trade at their own will and applied the proper risk management principles, they would be able to build up a sample size of trades they can learn from, but with the PDT, it would take a longer time to build the sample size, because it will not be possible to trade every day.
PDT is a reality traders have to deal with and the ubiquity of the commission free trading that large discount brokers enjoy, has made the rule more pleasant.