Pattern Day Trader RuleI’m Markus Heitkoetter and I’ve been an active trader for over 20 years.
I often see people who start trading and expect their accounts to explode, based on promises and hype they see in ads and e-mails.
They start trading and realize it doesn’t work this way.
The purpose of these articles is to show you the trading strategies and tools that I personally use to trade my own account so that you can grow your own account systematically.
Real money…real trades.
Now I want to talk to you about the pattern day trader rule because this rule requires that you have at least $25,000 in your trading account if you are day trading.
Here’s the tricky part.
The tricky part is that you could trigger this rule even if you’re only swing trading, and not day trading, which is why it’s important that you are aware of what the pattern day trader rule is.
I will give you examples of what can trigger it, even if it’s accidentally, and I’ll break down what then happens if you trigger it.
Most importantly, I want you to be aware of how you can avoid it.
What Is The Pattern Day Trader Rule?
So what is the pattern day trader rule? According to FINRA, who set the rule, a pattern day trader is a trader if you execute 4 or more day trades in 5 trading days.
So if you execute 4 or more day trades in 5 trading days, then you’re being flagged as a pattern day trader. This is not a good thing.
So what actually is a day trade? A day trade is a trade that you open and close, during a trading day.
So as an example, if you buy a stock at the open, at 9:30 Eastern Time, and then sell it before 4:00 pm Eastern Time, you are placing a day trade.
Now, very, very important: this whole rule only applies to stocks and options.
It does not apply to futures, forex, or binary options. It only applies to stocks and options.
How To Trigger The Pattern Day Trader Rule
How can you actually trigger this rule even if you’re swing trading?
Well, it actually happened to me very recently.
My head coach, Mark Hodge, and I, we were trading with our Mastermind members.
I asked Mark to place a trade in my account, but he accidentally placed it in the wrong account.
When something like this happens, I have a rule.
“When you make a mistake, liquidate.”
So I asked Mark to close the position, and when he did that counted as a day trade.
So we opened the trade, realized we made a mistake and closed it right away.
This lead to me having one strike in this account.
And again, if we would get 4 strikes within 5 business days, then we are flagged as pattern day traders.
Now, here’s another scenario. Let’s say that we enter a trade tomorrow and it hits the profit target or stop loss on the same day.
So this would be another strike because now we are also entering and exiting during a trading day.
So as you can see with this, even if you’re not day trading, it is possible that this could happen a few times.
If this happens 4 times within 5 trading days, then you’re flagged as a pattern day trader.
What Happens When You Trigger The PDT Rule?
What happens when you trigger this rule? Well, first of all, if you have more than $25,000 in your account, nothing happens.
This is because the pattern day trader rule says, if you are a pattern day trader, then you need to have $25,000 in your account.
Now if you don’t have $25,000 in your account, then you will be restricted to trade on a cash basis only for 90 days.
What does this mean? Well, see, as a day trader, you actually do need a margin account, and when you trigger the pattern day trader rule and cannot put $25,000 in there, this means that now you are restricted to trading with cash only.
So let me give you an example. Let’s say you are trading the Wheel trading strategy, and you put $20,000 in an account.
This means if you put it into a margin account, that you get $40,000 in buying power.
So when you trigger the day trading pattern rule, you no longer get this buying power here, the 2:1 leverage.
You are now basically going back to whatever cash you put in there when you trigger this rule.
How To Avoid Triggering The PDT Rule?
Now the question is, how can you avoid this? Well, and I want to give you three tips for how to avoid it.
Number one, have $25,000 in your account because if you have $25,000 in the account, then triggering the rule won’t matter.
What about if you don’t.
Number two, you want to make sure that you count the number of day trades.
Leave the date you placed a day trade on a sticky note, and count the number of day trades that you do even if it is accidental, so you can keep track of how many strikes you have.
Number three, you can avoid it here by trading a cash account.
So if you’re not trading a margin account, you don’t have to worry about it.
Then, of course, if you are trading futures, forex, bitcoins, so cryptocurrencies, or if you are trading binary options, this is also when the day trading pattern rule does not really matter.
Summary
Now you know what the pattern day trader rule is, how you can trigger it, even if it is accidentally, what happens when you trigger it, and how you can avoid this.
So let me ask you this, at this point, was this helpful at all? If so, feel free to share this video on Facebook, on Twitter, and I’ll see you for the next article.
Patterndaytrader
The Stigma of Options Pattern Day TradingIs there a pattern to your trades?
Anyone trading options knows how little effort it takes to build up a healthy volume of transactions. But you should be aware of one rule that could inhibit your ability to trade options too often in a margin account.
In the past, day trading represented the wild west of the market. It was possible for day traders to move in and out of positions within the trading day and end up with no open positions. Margin is calculated as of the ending positions in the trading day; this meant it was possible to trade on large volume with little or no cash at risk, meaning no margin requirements. It also meant huge risks for brokers.
Trading on extreme leverage is attractive, but it is not the only motive for day trading. Many traders believe that the risk of price gaps between today’s close and tomorrow’s open are simply too great; day trading enables traders to close out positions during the trading day, avoiding this risk altogether. Even so, if you want to day trade, you could fall into the definition of a “pattern day trader.”
Entry and exit decisions are based on momentum, chart patterns, and other technical strategies. Whichever strategy employed, the theme to day trading is that positions are opened and closed before the trading day’s end. This problem, at times representing unacceptable risks to brokers as well as to traders, is what led to the enactment of new rules concerning so-called pattern day traders.
By definition, a day trade is when you buy-to-open and sell-to-close or sell-to-open and buy-to-close the same option within the same market day. A pattern day trader is when this action is repeated four or more times within five consecutive trading days using a margin account. If you fall into this definition, you must maintain at least $25,000 in equity balances (cash and securities) in your margin account. This balance has to be on hand before you can continue any day trading. You can also be labeled a pattern day trader by your broker if your broker believes there is a strong likelihood that you will day trade.
One exception: If your day trading is lower than 6% of the total number of trades you make in the five-day period, then you are not considered a pattern day trader. So, high-volume traders can escape the rule under this provision.
Once you have been labeled a pattern day trader, you will need to maintain at least a $25,000 equity value in the account . If your account falls below $25,000, it will be frozen from day trading until the account is restored to the minimum equity requirement of $25,000.
Example of day trading:
8/18 10:10 AM BTO AUG-21 TSLA 1900 Call
8/18 10:50 AM STC AUG-21 TSLA 1900 Call
This is a day trade. The position was opened and closed in the same trading day.
Example of not day trading:
8/17 3:50 PM BTO AUG-21 TSLA 1900 Call
8/18 10:50 AM STC AUG-21 TSLA 1900 Call
This is not a day trade. The position was opened and closed on two different trading days.
Example of Pattern Day Trading:
8/13 Opened and closed an AMZN Put
8/13 Opened and closed a GOOG Call
8/17 Opened and closed a BKNG put
8/18 Opened and closed a TSLA call
This is pattern day trading. There have been four day trades in a five trading day period. Trading days do not include weekends for stock/index/ETF options. If instead of taking the TSLA call on 8/18, the position was day traded on 8/21, this would not have been classified as pattern day trading. This is because the fourth day trade, TSLA, would have been over five business days away from the first day trade on 8/13. See below:
8/13 Opened and closed an AMZN Put
8/13 Opened and closed a GOOG Call
8/17 Opened and closed a BKNG put
8/21 Opened and closed a TSLA call
This is not pattern day trading. Assuming no day trades were placed prior to 8/13.
The pattern day trading requirements is one of those unexpected surprises many traders discover in their margin accounts. The rules are easily understood in hindsight, but unfortunately, they are likely to come to your attention only after you fall into the zone in which they kick in and apply to you.
Individual brokers may have more strict rules regarding pattern day trading. For example, one broker may view the opening and closing of a vertical debit spread as one day trade, while another broker may view the same action as two day trades, since a spread has two different options. It is always important to contact your broker to understand how their day trading rules apply to you and your account. They will also have a record of your current day trades. If it is posted on your platform, make sure you know how to locate the day trade count if you intend to avoid being labeled a pattern day trader and are looking to stay at three day trades or lower in a five trading day period.