Pattern day trading is not illegal. But, it is something that traders need to think about when they choose to trade stocks or options versus commodities and futures. Pattern day trading applies to trading stocks and options and occurs when one makes four or more day trades on the same account over five days while using a margin account. Pattern day trading does not apply to futures or commodity day trading.
If a stock trader makes four or more day trades over five business days and the number of day trades of stocks or options exceeds six percent of the total trade activity of the margin account, their broker will flag the account as a pattern day trader. Why is this? Is pattern day trading illegal? No, it is not, but it can be dangerous for inexperienced traders. “Pattern day trader” is a regulatory definition of FINCA, the Financial Industry Regulatory Authority. When a trading account has been flagged for pattern day trading, the trader has his or her trading activity limited.
Commodity and Futures Traders Do Not Have Pattern Day Trader Designation
Just like with Day Trading Taxes, there are important differences between trading stocks and trading futures or commodities. When someone who day trades stocks passes the pattern day trader threshold, they must maintain a margin account in excess of $25,000 and risk losing their ability to trade if they cannot replenish their account in the event of a margin call. This is not the case if you day trade either futures or commodities. You simply need to have the sum of the amounts required for each individual commodity or futures trade. The remainder of this discussion has to do with pattern day trading as it applies to trading stocks and options and the hoops you may need to jump through.
What Is Considered Pattern Day Trading?
The pattern day trading definition applies to traders with margin accounts and not cash accounts. For such traders, the trades in question are “round trips.” Either the trader buys and then sells a security, or sells short and then buys, completing the “round trip” within one day’s trading session. When he or she does this four or more times over a period of five consecutive business days, the brokerage firm automatically flags their account and they are a pattern day trader.
Pattern Day Trading Regulations
The initial designation of someone as a pattern day trader is automatic. Then the trader must keep at least $25,000 in their margin account prior to every trading day. However, if over a period of three months, the trader makes no day trades, the restrictions can be dropped. The New York Stock Exchange requires brokerage firms to track the trader’s daily margin NYSE rule 432.) Should the trader begin day trading again, the brokerage firm does not need to wait until the trader has made four or more day trades over five days in order to flag the account again. Suspicion that the trader is resuming “pattern” activity is sufficient to require this.
Pattern Day Trading Violation
When a day trader “crosses the line” to becoming a pattern day trader both FINRA and the NYSE treat them differently than other traders. First of all, they need to have $25,000 in their margin account before the start of every trading day. In the event that the margin account falls below $25,000 the trader is subject to a margin call. He or she can restore the account to more than $25,000 with cash or “marginable equities.” The trader has five days to deposit the necessary money and all deposits are subject to a “no withdrawal” requirement for two business days. Traders are not allowed to use cross guarantees to satisfy margin requirements and all margin requirements need to be satisfied each in its own turn. When a trader is not able to meet their day trading call, their account’s buying power will be restricted for 90 days or at least until the margin call is met.
How to Avoid Pattern Day Trading
How to avoid pattern day trading restrictions is to pay attention to how many day trades that you make and how often. But, if you are good at day trading and making money, you will trade a lot and will be a pattern day trader. If you are a successful and serious day trader, you will commonly have a margin account in excess of $25,000 anyway! So, if your intent is to become a successful day trader you will naturally become a pattern day trader. You will hone your skills to be able to use advanced trading strategies and will efficiently manage your trading capital so that, among other things, you don’t get in trouble with pattern day trading requirements.
What Is the Pattern Day Trading Rule?
What gets you designated as a pattern day trader is trading a lot over just a few days. If you want to avoid this designation, you simply need to watch out and not trade more than four day trades over a five day period. The basic pattern day trading rule once you are a pattern day trader is to maintain your margin account at more than $25,000 before the start of every trading day. And, the rule if you want to be a successful trader who trades a lot is not to worry about the pattern day trader designation.
Pattern Day Trading Explained
One way to look at pattern day trading is to decide if carrying a margin account of $25,000 or more is going to be a problem. If not, and you are making money at day trading, being designated as a pattern day trader will not be an issue. If the size of your margin account is an issue, then you simply need to pay attention to how many trades you open and close within consecutive business days. Obviously, if you are trading a trend by jumping in and out, there may come a point where you need to decide if you are going after the next trade or if you are going to give it a rest so that you don’t get tagged as a pattern day trader.
Rules for Pattern Day Trading
There are rules for if you want to avoid being a pattern day trader and there are rules for pattern day trading if you have that designation. To avoid being a pattern day trader you need to pay attention to how much you trade using your margin account. If you have been designated as a pattern day trader, you need to make certain to keep your margin account above $25,000 at the start of every trading session. And, you need to promptly replenish your margin account in the event that your balance falls below $25,000.
The Last Rule: Think about Trading Commodities and Futures instead of Stocks
There are reasons for the Pattern Day Trader rules for stock and option trading. But, there is nothing in these rules that makes you trade stocks and options as opposed to futures and commodities. For more insights regarding your day trading and which securities to trade, contact us at Day Trade Safe.
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