As a day trader, you should know the pattern day trader rule and how it can impact you. The PDT rule restricts traders who engage in excessive activity. If you meet specific criteria and trade more than four times within five business days, it’s possible that your account could be suspended or closed by your broker. These are situations you don’t want, and there are some important rules you need to know before you start. Hence, we’ve compiled this guide on pattern day traders and how many trades you can make in a week.
Table of Contents
What Is A Pattern Day Trader?
A pattern day trader (PDT) executes four or more day trades within five business days; this includes one transaction per day. Those identified as PDTs must follow specific rules by The Financial Industry Regulatory Authority (FINRA).
What Is the Maintenance Margin?
Maintenance margin is the amount of equity you must always have in your account so you don’t get classified as a pattern day trader. This rule uses this minimum requirement as a benchmark for when it should be triggered.
If you don’t meet this level on any given day, the number of trades you make in the week or month may be restricted.
What Is Margin Call?
A margin call is a demand by the brokerage firm that you deposit more money into your account. The margin call is issued when the value of your account falls below the maintenance margin. In case you didn’t know, the maintenance margin is set by both regulators and individual brokerage firms.
If the equity in your securities portfolio goes below this pre-determined level, you’re not allowed to hold positions overnight. A scenario like this is “failing to meet required maintenance requirements.”
You’ll either have to sell off some holdings or add more cash to bring up their equity above this threshold (in other words: pay down their debt).
And did you know if you get a margin call, you have only five business days to answer it?
What Happens If I Don't Answer My Margin Call?
A few things. Firstly, your trading is restricted to two times the maintenance margin excess. That is, until you drop some cash into your account.
Secondly, it’s considered default if you don’t answer your broker’s margin call. A default means that the brokerage firm gets to sell your securities at market price. They do this to raise enough money to cover their loaned funds.
If this happens, they will have lost some of their capital and made interest on those funds during that time.
Are There Benefits to the PDT Rule?
There are many benefits to PDT. The first and most obvious advantage is that it allows you to make more and larger trades. This can greatly increase your chances of success. If you only have one chance to trade a week, your odds of success go down.
However, this also opens one up to more risk, especially the risk of over-trading. Luckily, Bullish Bears has extensive courses on risk management, so you won’t go blowing up your account.
PDT Example
I assume I have $100,000 of assets in my margin account in this example. As per FINRA rules for margin accounts, I must own at least 25% of those assets.
In any case, that equals $25,000. However, if my equity increases to $30,000, I’m $5000 over my maintenance margin.
As a pattern day trader, I can buy up to four times the excess of my maintenance margin. In this scenario, it’s $5000 (maintenance margin excess) times four which equals $20,000 worth of stock.
For someone who isn’t a PDT, they’re typically only able to trade two times their maintenance margin excess. They can only trade $10,000 worth of stock if we take the same numbers above.
How To Avoid The PDT Rule
As a day trader, you should know the PDT rule and how it can impact your trading. The PDT rule restricts traders who engage in excessive trading activity.
If you meet specific criteria and trade more than four times within five business days, it’s possible that your account could be suspended or closed by your broker.
To Avoid Being Classified as a Pattern Day Trader
Don’t trade more than four trades within five business days in your margin account.
Trade futures contracts (these are not subject to margin requirements).
Avoid margin accounts altogether. Instead, open an account with leverage based on cash deposited rather than borrowing money from the broker or institution.
Hold long and short positions overnight and sell them BEFORE you buy any new stocks the next day.
Always maintain $25,000 in margin in your account.
Avoid the PDT Rule by Trading Equity Futures
Did you know that futures traders aren’t subject to FINRA’s PDT rule? Yes, you read that right. You don’t need to register as a PDT if you’re only trading futures contracts. The FINRA regulation only applies to buying and selling stocks, options, and other securities.
Conclusion
You can make as many trades as you want in a week. But be aware of the PDT rule and how it can impact your trading.
The PDT rule restricts traders who engage in excessive trading activity. If you meet specific criteria and trade more than four times within five business days, it’s possible that your account could be suspended or closed by your broker.
We hope this article has helped you understand the PDT rule better. If you want to avoid this rule, we recommend that you trade cautiously and ensure that each trade is worth the risk before making it.
Also, remember that other factors are involved, such as margin calls and maintenance margins which may cause problems for those who don’t know what they’re doing! If you’re ready to start, Bullish Bears has fantastic deals for new members.
