If you have four or more day trades in any five-day period, meaning you enter and exit a single position in the same trading day, then you are classified as a “pattern day trader.”
While that on its own is not a bad thing, what happens because of the FINRA regulations on day trading can set you back up to 90 days.
Pattern day trading is defined by FINRA as “any customer who executes four or more “day trades” within five business days.” The rule goes on to specifically include individuals with margin accounts with an equity value of less than $25,000.
The pattern day trading rule was created by FINRA in an effort to curb people trading themselves into bankruptcy. The thought was that anyone who had at least $25,000 could afford to get into and out of trades without too much risk of blowing up their account. Because, of course, they must be financially savvy enough to have saved $25,000 to trade with in the first place (heavy sarcasm intended). Brokers are required to lock your account for up to 90 days if a PDT violation has occurred.
Here are three ways to ensure that you never run into the pattern day trading rule:
- Limit yourself to only two day trades in any given week Monday to Friday. You would run into an issue with four or more trades in a given five-day period. So by sticking to one day trade per day and a max of two in any calendar week, you should avoid that completely.Let’s say for example you put on one day trade on Monday, then again on Thursday. That gets you to two day trades in a five day period.You could even put on a third day trade the following Monday. That gets you to only three in a five day window.On the Tuesday of the following week, the first day trade place the previous Monday is no longer counted toward the three in five days limit, however you still have trades from last Thursday and this Monday within your PDT window.The max two-in-a-week rule should be the go-to rule for anyone with an account less than $25,000 looking to take advantage of intraday swings.
- Hold trades overnight. By holding your trade from one trading session to the next, from Monday to Tuesday or from Friday to Monday, ensures that these trades are not counted as day trades. They can be opened and closed within 24 hours, but it has to be in a separate trading session.
- Trade with a cash account. Most brokers allow you to choose what kind of account you want, cash or margin. Margin accounts allow for much greater flexibility and buying power, but with a cash account, you can only trade with available cash and you must wait for the funds to settle in order to trade again. Cash accounts bring in their own set of potential issues like Cash Liquidation Violations, Good Faith Violations and Free Riding Violations all of which are beyond the pattern day trading violations and are easily avoided with margin accounts.
It’s very likely that beginning traders will run into at least one of these headaches over the course of their trading career. The key is being aware and learning how to trade within the rules rather than trying to outsmart the system.
All of the above applies to options trades and stock trades. Your best bet is to stick to a plan and try to build up your equity to a point where you don’t have to worry about the restrictions anymore.
Christopher M. Uhl, CMA, MOSM
10minutestocktrader.com
Email: chris@10minutestocktrader.com
Twitter: @10minutetrading
Instagram: @10minutetrading