Do you actively trade stocks? If so, it's important to know what it means to be a "pattern day trader" (PDT) because there are requirements associated with engaging in pattern day trading. Once you understand the requirements you must meet, you reduce the risk that your firm will place restrictions on your ability to trade.
What Is Day Trading?
Day trading refers to a trading strategy where an individual buys and sells (or sells and buys) the same security in a margin account on the same day in an attempt to profit from small movements in the price of the security. FINRA’s margin rule for day trading applies to day trading in any security, including options.
Day trading in a cash account is prohibited.All securities purchased in the cash account must be paid for in full before they are sold.
Who Is a Pattern Day Trader?
According to FINRA rules, you’re considered a pattern day trader if you execute four or more "day trades" within five business days—provided that the number of day trades represents more than 6 percent of your total trades in the margin account for that same five business day period.
There are two methods of counting day trades. Please contact your brokerage firm for more details on how they count trades to determine if you’re a pattern day trader.
The rules also require your firm to designate you as a pattern day trader if it knows or has a reasonable basis to believe that you’ll engage in pattern day trading. For example, if the firm provided day-trading training to you before opening your account, it could designate you as a pattern day trader.
In general, once your account has been coded as a pattern day trader account, a firm will continue to regard you as a pattern day trader, even if you don’t day trade for a five-day period, because the firm will have a “reasonable belief” that you’re a pattern day trader based on your prior trading activities. If you change your trading strategy to cease your day trading activities, you can contact your firm to discuss the appropriate coding of your account.
What Are the Requirements for Pattern Day Traders?
First, pattern day traders must maintain minimum equity of $25,000 in their margin account on any day that the customer day trades. This required minimum equity, which can be a combination of cash and eligible securities, must be in your account prior to engaging in any day-trading activities. If the account falls below the $25,000 requirement, the pattern day trader won’t be permitted to day trade until the account is restored to the $25,000 minimum equity level.
In addition, pattern day traders cannot trade in excess of their "day-trading buying power," which is generally up to four times the maintenance margin excess as of the close of business of the prior day. Maintenance margin excess is the amount by which the equity in the margin account exceeds the required margin.
What if I Get a Margin Call?
If a pattern day trader exceeds the day-trading buying power limitation, a firm will issue a day-trading margin call, after which the pattern day trader will then have, at most, five business days to deposit funds to meet the call. Until the margin call is met, the account will be restricted to a day-trading buying power of only two times maintenance margin excess based on the customer's daily total trading commitment. If the day-trading margin call is not met by the deadline, the account will be further restricted to trading only on a cash available basis for 90 days or until the call is met.
Any funds used to meet the day-trading minimum equity requirement or to meet a day-trading margin call must remain in the account for two business days following the close of business on any day when the deposit is required. The use of cross-guarantees to meet any day-trading margin requirements is prohibited.
Why Do I Have to Maintain Minimum Equity of $25,000?
Day trading can be extremely risky—both for the day trader and for the brokerage firm that clears the day trader’s transactions. Even if you end the day with no open positions, the trades you made while day trading most likely have not yet settled. The day trading margin requirements provide firms with a cushion to meet any deficiencies in your account resulting from day trading.
Most margin requirements are calculated based on a customer's securities positions at the end of the trading day. A customer who only day trades doesn’t have a security position at the end of the day upon which a margin calculation would otherwise result in a margin call. Nevertheless, the same customer has generated financial risk throughout the day. These rules address this risk by imposing a margin requirement for day trading calculated based on a trader’s largest open position during the day rather than on open positions at the end of the day.
Firms are free to impose a higher equity requirement than the minimum specified in the rules, and many of them do. These higher minimum requirements are often referred to as "house" requirements.
Is Pattern Day Trading Right for You?
Before you come to any conclusion, read and consider the points set forth in the Day-Trading Risk Disclosure Statement embodied in FINRA Rule 2270. In addition to minimum equity requirements, day trading requires knowledge of both securities markets in general and, more specifically, your brokerage firm's business practices, including the operation of the firm's order execution systems and procedures.
Day trading generally isn’t appropriate for someone of limited resources, limited investment or trading experience and low risk tolerance. A day trader should be prepared to lose all of the funds used for day trading. Given the risks, day-trading activities shouldn’t be funded with retirement savings, student loans, second mortgages, emergency funds, assets set aside for purposes such as education or home ownership or funds required to meet living expenses.
As an experienced financial professional with a deep understanding of the intricacies of trading and financial regulations, it's imperative to shed light on the concept of being a "pattern day trader" (PDT) and the associated requirements. My expertise in financial markets and regulatory frameworks allows me to provide insights that go beyond the surface, ensuring a comprehensive understanding of the matter.
Day trading, a strategy where individuals aim to profit from small price movements in a security within the same trading day, is subject to specific regulations outlined by the Financial Industry Regulatory Authority (FINRA). As an enthusiast well-versed in the subject, let's delve into the key concepts presented in the article:
1. Day Trading and Margin Accounts:
- Day trading involves buying and selling the same security on the same day, typically in a margin account.
- FINRA's margin rule for day trading applies to trading in any security, including options.
- Cash accounts are prohibited for day trading; securities in cash accounts must be paid for in full before selling.
2. Pattern Day Trader (PDT) Definition:
- According to FINRA rules, a pattern day trader is one who executes four or more day trades within five business days.
- This designation is made if the day trades represent more than 6 percent of total trades in the margin account during that period.
3. PDT Requirements:
- Pattern day traders must maintain a minimum equity of $25,000 in their margin account on any day they engage in day trading.
- The $25,000 minimum can be a combination of cash and eligible securities.
- Day traders cannot exceed their day-trading buying power, generally up to four times the maintenance margin excess.
4. Margin Calls and Restrictions:
- If a pattern day trader exceeds the day-trading buying power, a firm issues a day-trading margin call.
- The trader has up to five business days to deposit funds to meet the call; failure results in account restrictions.
5. Rationale Behind $25,000 Minimum Equity:
- The $25,000 minimum equity requirement serves as a cushion to cover potential deficiencies resulting from day trading.
- Day trading involves risks, and the margin requirement is calculated based on the trader's largest open position during the day.
6. Day-Trading Suitability:
- Day trading is risky and may not be suitable for everyone.
- Traders need knowledge of securities markets, brokerage firm practices, and risk tolerance.
- Day trading shouldn't be funded with crucial funds like retirement savings, student loans, or emergency funds.
Conclusion:
In conclusion, understanding the regulations and requirements associated with pattern day trading is crucial for anyone actively involved in stock trading. These rules are in place to mitigate risks for both traders and brokerage firms, ensuring a level of financial stability and responsibility in the dynamic world of day trading. As you navigate this financial landscape, it's essential to be well-informed and make decisions that align with your financial goals and risk tolerance.
