What is the pattern day trading rule?
The pattern day trade rule or PDT rule refers to the FINRA and SEC guidelines which state that a day trader must have at least $25,000 in equity on any day that they day trade, prior to engaging in any day trading activity. A pattern day trader can execute four or more day trades within 5 business days inside of a margin account. Forex PDT rule doesn’t exist and forex traders can trade without limitations. So far it seems that indeed new traders must have at least $25,000 in cash in order to begin day trading. This can be overwhelming and prevent many people from getting started. Fortunately, you do not actually need this sum of money to begin, you only need to abide by this if you fit the criteria for a day trader.
The pattern day trade rule or PDT rule applies only to all FINRA regulated brokers.
Let we see PDF rules and stocks trading
The last part of the sentence is the key piece of information “inside of a margin account”. The definition of a pattern day trader includes quite a few limitations.
First of all, what exactly is considered a day trader?
If you’re interested in day trading then you probably have at least a bit of knowledge on what a day trade actually is but you may not know an important piece of information. The definition of a day trade is when you purchase and sell a stock between the market open and the market close for the same day. If you were to hold your position overnight then the trade would no longer be considered a day trade, it would instead be considered a swing trade.
Therefore the pattern day trade rule does not limit you from making more than three trades per week with a small account balance. The rule only limits you from making three intraday trades per week. You may be thinking to yourself that 3 intraday trades it not much at all. In my opinion, I would say that the pattern day trade rule is actually a good thing for new traders. The be impacted by this in the first place, you would need to have a relatively small account size. This small account size is likely due to a lack of experience, hence the small balance. PDT rule will prevent you from making a bunch of unnecessary trades and blowing your whole account as many new traders have done trying to trade between every dip and rise.
The second criteria to the pattern day trade rule
The second requirement to be considered a day trader is that you must make at least 4-day trades a week. This may not seem like a lot but that is actually quite a bit.
If you’ve never heard of leverage, allow me to explain. Leverage is where the broker you are with will allow you to trade with more than you have. Some brokerage will put up a 4:1 ratio or even a 6:1 ratio. So basically if you have $1000, you could trade with $4000 or even $6000 in certain cases. Even though this may seem enticing, I would not recommend it. Using leverage is basically gambling. The reason for this is that you can lose much more than trading with your own money. This is because it will not feel like you are trading with your won money, therefore you will have a lot less emotional attachment to it. Using leverage is not recommended for this very reason. If you are not planning on using leverage then you will not need a margin account.
The final part of the pattern day trader rule is that it only applies if you are utilizing a margin account. If you are using a regular cash brokerage account then the rule will not impact you.
The day trade limit of $25K
Let’s say that you have opened a margin account and do wish to make more than 4 intraday trades with a week. In this case, you will need to maintain a balance of at least $25k within your margin account in order to abide by the pattern day trade rule.
The day trading rule for an account with under $25K
If you have opened a cash or margin account with under $25K and wish today trade then this is still possible, you will just need to find loopholes with the rule.
As I stated before, if you have a cash account then you will be just fine to day trade without leverage and not have to worry about this rule. This is a great option since it will encourage you to be smart with your money and take calculated positions.
You will also be able to day trade in foreign exchange markets and forex if that interests you. You will be able to make more trades and utilize less money.
Why was the PDT (pattern day trade) rule put into place?
Pattern day trade was created to make sure that smaller inexperienced investors and traders don’t day trade until their accounts have values over $25,000. This amount for SEC represents enough risk capital to offset any self-inflicted damage trading might create financially.The primary mission of the SEC is to protect investors and maintain the integrity of the securities markets (both formal exchanges and over-the-counter).The SEC considers day trading to have a significantly higher risk than buy and hold strategies.
Situations where the pattern day trade rule may apply
Let’s say for example that you decide to open up a margin account with a broker and deposit $15,000. On day 1 (Monday) you decide to buy and sell leveraged shares of stock XYZ. On day 2 (Tuesday) you buy and sell stock ABC. On day 3 (Wednesday) you short sell DEF. Finally, on day 4(Thursday) you buy and sell shares of both ABC as well as XYZ. This would be counted as 5 trades in 4 days which would place you under the criteria of a pattern day trader. Let’s say in this scenario you have $20,000 in your brokerage account, in order to follow the FRNA guidelines, you would have to deposit an extra $5,000.
Tips for following the pattern day trade rule
In the beginning, this rule can cause a lot of frustration. It limits you on what you are able to do with your own money. Over time you will find ways to work around it! It can be tough at times to watch the market rise and fall and not be able to take any action. In this case, it would be a good idea to use a practice account t times. Paper trading is great for building your skills. I suggest that you do your best to maintain profitability and not lose too much of your paper profits. Paper trading is far easier than trading with real money. This is again because paper-trading will give you no emotional attachment as it is not real money. You’ve probably heard the statistic that 90%+ of day traders lose money. This is due to a lack of emotional discipline which must be formed over time and with practice. Contrary to popular belief, you don’t need to make that many trades in a week to achieve wealth. What’s more important is making the right trades. Keep reading to learn some more tips on how to avoid joining the 90% statistic!
Avoid using too much leverage
Although I already mentioned this, it deserves to be repeated. Using leverage is a great way to lose a large sum of money. Why you may ask? Because you are using someone else’s money on a position that may not work out. If you open up a cash account as oppose to a margin account then this is something you don’t have to worry about.
Don’t make more than three-day trades a week
This is especially important for newbie traders. This is a good rule to follow whether you have a margin account or a cash account. Buying shares of multiple stocks that interest you will hinder your concentration. When day trading it is important to stay focused which is why it is usually better to take fewer positions.
Focus on the 80-20 principle
The 80-20 principle is probably something you’ve heard of before. The 80-20 principle is something that can be applied to a wide variety of things. the stock market is a great aspect that it can be applied to. In the stock market. In the stock market, it basically means that about 80% of your income will come from 20% of your trades.
Goal setting is something that is extremely important in general. Investing in the stock market is no exception. Goals are important in the stock market because without defined goals you won’t have anything to work towards. Think about what you would like to accomplish by trading stocks. Whether its financial freedom or buying a new Ferrari, setting goals is something you should definitely practice.
Learn as much as possible
If your a newbie to the stock market then the best advice I can give you is to learn as much as possible. Learning the ins and outs of the stock market will take time but it will be worth it because it will give you the best chance at making it big in the stock market.
Now you know exactly what the pattern day trade rule is and who it impacts. Hopefully, you found this article informative as well as entertaining to read.
Pattern Day Trading Rules do not apply to forex, so all these article facts are important only for stock traders.