All traders and investors should be aware of the pattern day trading rules. Learn more about the required minimum equity and the number of trades you can make.
By Karl Montevirgen March 23, 2023 5 min read
5 min read
Photo by TDAmeritrade
Key Takeaways
- You can violate the pattern day trader (PDT) rules without realizing it
The consequences for violating PDT vary but can be inconvenient for investors who are not actively trading
For active investors who want to place an occasional day trade, learn how margin and open positions can affect total trade equity to help avoid PDT violations
You’re not normally a rule-breaker. But violating the pattern day trader rule is easier to do than you might suppose, especially during a time of high market volatility. Don’t let this happen to you. Here’s what you need to know. First, a hypothetical. Suppose you bought several stocks in your margin account. Minutes or hours later, you change your mind, so you sell them. Your “round trip” (buy and sell) trades all took place on the same trading day. If you execute four or more round trips within five business days, you will be flagged as a pattern day trader. Here’s where you might be dinged: If you’re flagged as a pattern day trader and you have less than $25,000 in your account, you could be restricted from opening new positions. So, what now? You’re in trouble, but what are the consequences? What if you do it again? 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. There are a few simple but strict rules that define pattern day trading. Let’s go over them.
Round Trip: There and Back Again
A “round trip”simply means opening and closing a security position. Whether you buy or sell to open, when you close the position, you’ve completed a round trip. If you did it within a single trading day, you’ve made a day trade.
A day trade happens when youopen and closeasecurity positionon thesame day. Let’s break that down:What exactly is a day trade?
- Open and close (round trip):When we say “open and close,” it means buying and selling, or for short sellers, selling (short) and then buying. This is also called a “round trip.”
- Security position:Day trading applies to virtually all securities—stocks, bonds, ETFs, and even options (calls and puts).
- Same day:If you do a round trip on the same day, it’s a day trade. If you hold your security position beyond the close of the trading day, it’s not a day trade.
What is a pattern day trader?
You’re a pattern day trader if you make four or more day trades (as described above) in a rolling five-business-day period,andthose trades make up more than 6% of your account activity within those five days.
There are different types of day traders, but we’ll focus on two:
- Self-identified day traders: This includes folks who are actually day traders, meaning their brokerage is aware that they intend to day trade and that they meet the $25,000 minimum account value requirement.
- Pattern day trading violators: These are people who day traded in violation of the rules without meeting the sufficient capital requirement.
Well, I violated the pattern day trader rules. What are the consequences?
Now what? It depends on your brokerage. For first-time offenders, the consequences might not be so bad, assuming your brokerage has a more forgiving policy.However, you’ll likely be flagged as a pattern day trader (in the violator sense) just so your broker can watch your activities for any consistent or repeat offenses. So, tread carefully.
If you make four day trades in a rolling five days, some brokerages may subject you to a minimum equity call, meaning you have to deposit enough funds to have the $25,000 minimum account value (even if you don’t intend to day trade on a regular basis). If you make an additional day trade while flagged, you could be restricted from opening new positions.
This is a big hassle, especially if you had no real intention to day trade. If you violated the pattern day trading rules by accident, or if you were tempted to take some profits (or close out losses) within the same day—enough to get flagged in violation—the hassle just isn’t worth the momentary lapse in caution. But if you inadvertently end up flagged as a day trader and don’t intend to day trade going forward, you can contact your broker who may be able to give you some alternatives to avoid trading restrictions.Regulatory guidance on flag removals is fairly strict and limited. With proper agreements in place, you may have the flag removed from your account one time. As you continue to trade, if your future trading activity constitutes pattern day trading, the pattern day trading flag will be placed back on your account, and it cannot be removed.
If you do want to officially day trade and apply for a margin account, your buying power could be up to four times your actual account balance. You could inform your broker (saying “yes, I’m a day trader”) or day trade more than three times in five days and get flagged as a pattern day trader. This allows you to day trade as long as you hold a minimum account value of $25,000—just keep your balanceabovethat minimum at all times.
Before you do that, be sure you really understand your account balance, as there are many things that can affect your trade equity, such as: 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. To learn more about day trading, watch the video below.I have a little over $25k. Can I place occasional day trades?
Bottom line
By Karl Montevirgen
Key Takeaways
- You can violate the pattern day trader (PDT) rules without realizing it
The consequences for violating PDT vary but can be inconvenient for investors who are not actively trading
For active investors who want to place an occasional day trade, learn how margin and open positions can affect total trade equity to help avoid PDT violations