Forex Trading

Pattern Day Trader Rule Definition and Explanation

Posted on 16.02.2023

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  1. Flagged accounts below this equity level can face restrictions, so it’s important to understand what counts as a day trade and what happens to your account once you’re classified as a pattern day trader.
  2. Round-trip trading can easily be confused with legitimate trading practices, such as the frequent round-trip trades made by pattern day traders.
  3. If your account equity drops below that $25,000-dollar threshold, you will not be able to complete any day trades or opening trades until your account goes back above the threshold.
  4. Later that day, you enter an order to sell to close those 300 shares.

The SEC implemented the mandatory $25,000 minimum account equity requirement for accounts that qualified as “Pattern Day Trader” under NASD Rule 2520 and NYSE Rule 431. The PDT Rule attempts to protect small account retail traders. The assumption is that retail customers with over $25,000 in account equity are assumed to be familiar with the accepted the risks entailed with day trading.

However, FINRA created this rule to help protect inexperienced investors from trading too often. It is intended to protect people from overtrading and blowing up their accounts. Day trading is subject to significant risks and is not suitablefor all investors.

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How Round Trip Transaction Costs Work

This practice is also known as churning or making wash trades. Even though many new traders end up hating the PDT rule, we should always keep in mind that it was designed to help us. Remember to keep track of your account equity and the total number of day trades in your account to avoid having to deal with the ramifications of this trading violation.

Under the PDT rule, a day trade is the purchase and sale, or sale and purchase, of the same security in a margin account within a single trading day, sometimes called a “round trip”. It applies to both long and short trades and includes pre- and post-market trading. You are a pattern day trader if you make more than four day trades (as described above) in a rolling five business day period, and those trades make up more than 6% of your account activity within those five days. More importantly, what should you know to avoid crossing this red line in the future? Keep in mind that you don’t have to borrow on margin to violate the pattern day trader rule. It’s a good idea to be aware of the basics of margin trading and its rules and risks.

This allows you to day trade as long as you hold a minimum account value of $25,000, and keep your balance above that minimum at all times. Round-trip trading, in terms of individual investors, refers to the practice of buying and selling the same security in the same trading day. Since this is a risky practice, many markets have regulations in place that prevent this from taking place unless the investor has a significant amount of money in his or her trading account. In terms of companies, round-trip trading takes place when a company sells an asset to another company and then buys the same asset back from the second company for the same price.

This means you can close existing positions but can’t open any new ones. The Equity Maintenance Call ends when either you bring the account equity above $25,000, or the PDT flag is removed from the account. A pattern day trading flag can only be removed one time from your account. If the account is later reflagged as PDT, the flag will remain on the account. The pattern day trader designation occurs when someone executes four or more day trades during a five business day period in the same margin account. Whenever you are designated as a pattern day trader, FINRA requires you to have a minimum of $25,000 combined value in securities and cash in your brokerage account as a means of mitigating risk.

What Is The Pattern Day Trade Rule?

If you’re concerned about being flagged as a pattern day trader, make sure you have a plan. Predetermine your entries and exits, and track when you place trades, so you know when you’ve hit your limit. Understanding and following PDT rules can help you avoid restrictions on your account. Getting dinged for breaking the pattern day trader rule is no fun. Of course, if you want to be a more active trader, possibly even do a little day trading on occasion, then you might go ahead and brush up on the rules concerning margin. Otherwise, if you can steer clear of violating the rules, or simply keep your account value well over $25,000, you’ll have less to worry about should you need to execute a short-term trade.

Keep Track of Your Round Trip Trades

Consider each round trip as a bullet in an ammunition clip that only holds three bullets. The longer you go without making a round trip, the easier it is to avoid the PDT Rule violation. Be conscious of when a round trip was executed and mark the days on the calendar. If you buy to open 300 shares and sell them off in three separate orders throughout the day, it’d still only be one day trade because there’s only one buy order. Before you do that, be sure you really understand your account balance, as there are many things that can affect your trade equity.

Avoid the Fourth Opening Trade Unless It is an Overnight Trade

By creating fake trading volume, round-tripping can also interfere with technical analysis based on volume data. As a trader, you owe it to yourself to gain a thorough understanding of the basic rules and concepts that dictate the parameters of your trading. Sure, developing a great trading strategy, finding the right stocks to trade, and understanding risk management are all vital to your overall success as a trader.

Therefore, the 3 round trips per rolling 5 business days’ period remain in tact. Investing and trading involve risks, including loss of principal. Schwab does not recommend the use of a day trading strategy. Round trip transaction costs have declined significantly over the past two decades due to the abolition bitbucket push and pull request of fixed brokerage commissions and the proliferation of discount brokerages. As a result, transaction costs are no longer the deterrent to active investing that they were in the past. As you can imagine, this can be extremely frustrating for new traders that want to continue their progress in the market.

Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.