Pattern Day Trader

Pattern Day Trader (PDT Rule) Explained

9 min read

What is the pattern day trader or pdt rule, and how do you get around it? Though the Financial Industry Regulatory Authority introduced the rule to protect traders, the pdt rule severely limits new day traders. It only allows traders to make three-day trades in five calendar days if they have less than $25,000 in an account. Many traders consider it a significant barrier to entry, stopping you before you even start. 

First, let’s talk about what a day trade is. In short, a day trade can be two transactions on the same financial instrument on the same trading day. If you buy and sell or short and buy back security within a day, it’s considered a day trade. Finally, any positions held overnight are not considered a day trade. 

If you don’t want to be under the pattern day trader rule, you must have $25,000 in your account. Otherwise, you’ll be restricted to 3-day trades in a five calendar day trading period. However, that’s not necessarily a bad thing. It can help you from blowing up your account when you’re new. 

Calculating the Number of Trades

If you’re still a bit unclear, here are some examples to help you understand:

  • If you enter one buy order for 4000 shares and sell two 2000 share orders, these three trades count as a day trade.
  • The reverse of the example above is also true. If you buy 2000 shares in two separate orders and close your position in one order of 4000, it’s considered a one-day trade.
  • Alternatively, placing two 400 share trade orders and closing with two 400 share orders counts as two-day trades. It counts as two separate day trades, as you have two transactions at either end.
Pattern Day Trader PDT Rule

Pattern Day Trader (PDT) Rules

If I had to describe the PDT Rules, I’d liken it to swimming in handcuffs. Many see the PDT rule as a horrific stifling of trader activity. Unfortunately, the PDT rule doesn’t allow more than 3-day trades in five days for trading accounts under $25,000. Under the rule, a day trader must maintain a minimum equity of $25,000 if day trading four or more times within five business days (5-day rolling period) with a margin account.

Furthermore, the number of day trades is more than six percent of the customer’s total trading activity for that same five-day period. 

Time Is Not on Your Side

Let’s be honest; we’d all love to start day trading with a minimum of $25,000. The average trader typically doesn’t have that amount of money to trade.

You could limit your intraday trading activities to three trades a week. Alternatively, you could trade using a cash account without leverage until you grow it enough to meet the $25,000 requirement. But, this can, and most likely will, take time.

Broken Down in 30 Seconds

  • A pattern day trader “day-trades four or more times in five business days, and the day-trading activity is greater than six percent of the total trading activity for the same five-day period.”
  • To avoid PDT designation, you need $25,001 in your trading account. Note that this money must stay in your account for two business days after you close your final trade.
  • The PDT rule only applies to day trading stocks and options.
COURSE
Day Trading Course Options Trading Course Futures Trading Course
DESCRIPTION Learn how to read penny stock charts, premarket preparation, target buy and sell zones, scan for stocks to trade, and get ready for live day trading action
Learn how to buy and sell options, assignment options, implement vertical spreads, and the most popular strategies, and prepare for live options trading How to read futures charts, margin requirements, learn the COT report, indicators, and the most popular trading strategies, and prepare for live futures trading
INCLUDED

Overcoming the Pattern Day Trader (PDT) Rule

Day Trading Futures

You don’t need $25,000 in your account to day trade futures. Luckily, the Pattern Day Trader rule does not apply to day trading futures. 

The rule only applies to day trading stocks and options. In futures and Forex, traders can open and close as many trades as they like within a day, trading without restriction and subject to margin requirements.

So what about E-mini futures, and why should all new traders trade the micro E-mini futures? At 1/10th the size of the E-minis, Micro E-mini Futures allow traders to access highly liquid index markets with reduced costs. You want to protect your account.

Margin Requirements

Now that I have your attention let’s talk about the future because who has $25,000 lying around in their account? Margin requirements for futures contracts can vary depending on the specific futures product you want to trade. 

Firstly, the initial margin requirements are typically a small percentage, ranging from 2% to 12% of the contract’s notional value. If you didn’t know, the notional value is the cash equivalent or the contract’s total value.

Secondly, the exchange sets the margin requirements for futures contracts, which can differ depending on the futures instrument you want to trade. 

Micro E-Mini Futures

  • Lower risk
  • $50 margins
  • $5 point value
  • $1.25 tick value
  • Low barriers to entry

You can get started with NinjaTrader for as little as $400

  • Round-the-clock trading
  • No need to be glued to your computer between 9:30 am and 4:00 pm
  • Highly liquid
  • Access to the most popular markets (S&P 500, NASDAQ 100, Dow Jones Industrial Average, Russell 2000)
  • Substantial tax advantages

Futures Can Be Risky

And that risk is leverage.

Leverage allows traders to amplify their trading power and increase the potential for profits. However, it is important to note that leverage can also magnify losses. Greater leverage means that even small price movements in the underlying asset can lead to significant gains or losses in the futures position.

Remember that margin requirements for futures contracts involve leverage, meaning that profits and losses can be magnified. Leverage in futures contracts refers to controlling a larger contract value with a relatively small capital. This is made possible through the use of margin, which is the initial funds or capital required to initiate a futures position. As mentioned above, the margin requirement is typically a percentage of the contract’s notional or cash value, ranging from 2% to 12%.

Pattern Day Trading Rule in Canada

There is no Pattern Day Trading (PDT) rule in Canada that is similar to the one implemented in the United States. In the U.S., traders who execute four or more day trades within five business days in a margin account with less than $25,000 are classified as pattern day traders and must maintain a minimum equity balance of $25,000. However, Canadian traders are not subject to these same regulations. In Canada, day trading margin rules are less strict, and intraday traders are generally not required to keep a minimum balance in their securities account.

Province Specific Rules

Traders in Canada should be aware of their broker’s and province’s securities regulator’s rules and requirements, even though there is no specific PDT rule in Canada. Knowing these regulations is essential to trade safely and legally. Each province has its own securities regulator, which sets rules and regulations for trading activities within the province. Traders should review the laws and requirements specific to their province before engaging in any trading activities.

The Canadian Income Tax Act has fewer regulations for day trading than the United States. However, if you are trading American investments, you must still follow the U.S. regulations. So yes, the PDT rules apply to Canadians who trade U.S. securities.

Final Thoughts: Pattern Day Trader (PDT Rule)

You want to make money. But how is that even possible with the hundreds of strategies and indicators available? Whether buying a box of crackers or trying to pick a day trading strategy, our everyday decisions, both big and small, have become increasingly complex due to the overwhelming abundance of choices presented to us. 

That’s why I say less is more regarding day trading. Contrary to popular belief, trading stocks don’t need to be complicated. 

You have hundreds of strategies at your fingertips, all profitable under the right conditions.

But your job isn’t to trade them all but to master one or two. There is no best strategy among them or right or wrong answer.

You need to find the one strategy that works best for you. My favorite trade strategies are VWAP, opening range breakouts, and the ABCD pattern.

Frequently Asked Questions

Pattern day trading is not illegal. However, the US government believes that it's really risky. Hence, the PDT rule is now in place. They're trying to save us from ourselves, which can be good if we pay those day-trading taxes.

In the United States, traders who make four or more day trades within five business days using a margin account holding less than $25,000 are designated pattern day traders. Such traders must maintain an equity balance of at least $25,000.

Yes, as long as you keep your account's $25,000 minimum equity balance. 

FINRA sets the regulation for a $25k equity requirement for day trading. This rule is intended to protect traders against the hazards of day trading. FINRA mandates a minimum equity of $25k to ensure traders have sufficient capital to endure potential losses.

Did you know that the PDT rule does not apply to future contracts? No PDT rule limits the daily trades a futures contract trader can make. The PDT rule is specific to day trading stocks and options. Futures contract traders can open and close as many trades as they like, provided they meet the margin requirements. How great is that?

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