When you’re new to day trading, it’s important to learn about the Pattern Day Trader rule. This rule can affect the way you can use your brokerage account. Keep reading to learn all about it.
What is the Pattern Day Trader Rule?
According to Financial Industry Regulatory Authority (FINRA), a pattern day trader (PDT) is someone who trades at least four times over the course of five business days and their day trading exceeds six percent of total trade activity during the same time period.
FINRA defines day trading as the buying then selling a stock on the same day, or selling short and buying the same security in the same day, also known as a “round trip.”
Established by FINRA, the pattern day trading rule requires a minimum equity of $25,000. This equity must be in your brokerage account before you day trade and be at or above $25,000. The equity can be a combination of cash and eligible securities.
Note: the Pattern Day Trader rule applies to margin accounts, not cash accounts.
Why is the Minimum Equity Requirement $25,000?
In 1974, the minimum equity requirement was established at $2,000. This was before technology made day trading easily accessible. Since a day trader is neither long nor short, there is no collateral that could be sold to meet margin requirements.
Brokerages gave input to FINRA to determine the $25,000 minimum, and many brokerages had a $25,000 requirement before the day trading rules were changed in 2001. Note: While FINRA has established a minimum for pattern day traders, your broker may require a higher amount to day trade.
Buying Power for Pattern Day Traders
Day trading accounts have 4 times buying power in your margin account. For example, if you have the minimum requirement of $25,000, you would have the buying power of $100,000.
What happens if my account goes below $25,000?
Once you are tagged as a pattern day trader by your brokerage, you will not be allowed to day trade until your account meets the $25,000 minimum.
What if I’m not a consistent day trader?
Usually, once your broker tags you as a pattern day trader, they will continue to see you as a day trader, even if you don’t day trade for a week due to your previous trading. If you have stopped day trading, you may want to contact your broker to discuss your options if you want to continue trading or investing in the stock market.
If you plan on day trading, it’s important to understand the Pattern Day Trader rule, especially as you are building your account to meet the minimum. If your number of day trades exceeds four trades and it exceeds 6% of all of your trades, your account will be tagged as a day trader and you’ll have to meet the equity requirement to continue trading.
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