What we'll cover
An introduction to day trading
The rules for pattern day trading
Examples of pattern day trading
If you're a regular day trader, you may know that understanding pattern day trading (PDT) rules can help you avoid complications. Even if you don't plan to day trade often, it's critical to understand exactly what constitutes a day trade.
First, what is a day trade?
Day traders open and close a position during the same day with the goal of profiting off any price changes, whether that means buying a security once the value goes up or short selling it if they think the stock will go down. Day traders try to use the market's volatility to their advantage, no matter which way it goes — up or down.
Like with all investing, but especially short-term, day trading comes with risk, since it's all about taking a chance on small price movements.
So, what is a pattern day trader?
Sometimes, day traders who use margin(increased leverage) with one account exceed four (or more) day trades in five business days.
When that happens, their brokerage firm must mark their account as that of a pattern day trader, provided that the number of day trades represents more than 6% of their total trades in the margin account for that same five-business-day period. Keep in mind a brokerage can choose to be stricter than the FINRA rules, so check the details with your specific firm.
Pattern day trading rules & examples
Patter day trading rules don't prevent trading — and they can help to protect traders.
What are the PDT rules?
PDT rules come from the Financial Industry Regulatory Authority (FINRA). Under the PDT rules, you must maintain minimum equity of $25,000 in your margin account prior to day trading on any given day. If the account falls below the $25,000 requirement, you cannot day trade until you are back at or above the $25,000 minimum.
Read Ally Invest's full day trading disclosure.
Brokers usually lock the account as soon as this rule gets triggered, but the lockout period varies, depending on the broker's guidelines.
You must follow the same margin requirements if you're an occasional day trader, meaning you must have a minimum equity of $2,000 to initially buy on margin and meet the Regulation T requirements.
You must have:
50% of the total purchase amount
Keep at least 25% equity in your margin account
Examples of pattern day trading
Let's look at an example of what might constitute a day in the life of a day trader:
Now, let's see how you might become “labeled" as a pattern day trader. Let's say you open a $10,000 trading account, then:
On Monday, you trade ABC stock.
On Tuesday, you trade DEF stock.
On Wednesday, you trade XYZ stock.
Since the pattern day trading rules trigger when you make four or more trades in a five business-day period, you can't day trade again until the next Monday. You can sell existing holdings provided they were not purchased the same day.
What happens if I’m flagged as a patter day trader?
Once your account triggers the PDT rules, your broker can issue you a margin call if you hold less than the minimum PDT equity requirement. You have, at most, five business days to deposit funds or eligible securities or raise your account to meet the call. If the call is not met, you may experience restricted, but not suspended, trading.
If you don't meet the margin call after five business days, your broker may place you under a 90-day cash restricted account status until you meet the $25,000 minimum.
Note: Ally Invest's Self-Directed Trading platform gives you a warning message if you start making your third day trade.
Leverage: A double-edged sword
Although you might think there is great benefit in accessing increased margin with a pattern day trade account, you can lose money.
In fact, when you day trade with borrowed funds, you can lose more than your initial investment. Since expenses can pile up quickly, you must monitor and control this expense.
Be prepared
Whether you’re a savvy trader or paper trading for the first time, take care to continue honing your investing skills and stay in-the-know on all things day trading.
