Day trading involves a degree of risk. Day traders are buying then selling or selling then buying the same security on the same day. The high-risk, high-frequency traders known as pattern day traders warrant regulatory scrutiny all their own. A pattern day trader makes four or more day trades during five business days. Here’s what a pattern day trader is, how they operate, and what kind cash they need to keep trading.
A day trader is a person who buys then sells the same security on the same day. It could also be someone who sells short then buys the same security in the same day.
A pattern day trader is someone who makes four or more of those day trades in a five-day time span. Those trades represent more than 6% of a pattern day trader’s total trades during a five-day period. They also can include stock options and short sales that occur on the same day.
A pattern day trader can hold a long or a short position in a stock overnight. However, if they are sold prior to buying the same security the next day, they are exempt from the pattern day trader rule. That’s important when you consider the cost of pattern day trading.
The Financial Industry Regulatory Agency (FINRA) requites a pattern day trader must have at least $25,000 in their margin account whenever they trade. That $25,000 can be strictly cash or cash and eligible securities.
If that account drops below $25,000, a pattern day trader can’t make any more trades until they meet that minimum. This will require you to deposit more funds into your account until you have the required $25,000 in your account.
In the event of a margin call, a pattern day trader has five business days to come up with the money. Until they do, they can only trade to a value of two times the maintenance margin.
If they can’t produce the margin funds within five business days, their account will be cash restricted for 90 days. That restriction can be lifted if the issues are cleared up.
Meanwhile, the funds must stay in the account for two business days from closing. Pattern day traders have no choice in this matter, as they can only trade from margin accounts.
Making a lot of moves may mark you as a pattern day trader. FINRA makes that determination, but your brokerage may have their own rules in place for day traders. Firms may limit you to trading less than four times a day. Robinhood, for instance, limits traders to three trades in a five-day span.
If you feel you make a high amount of trades in a short amount of time, you may want to contact your brokerage to see if you fit the bill. To be considered a pattern day trader, you must:
- Have $25,000 in minimum equity for each account you wish to use.
- Trade up to four times the maintenance margin access in the account you’re using.
- Refrain from using multiple accounts to hit the minimum equity requirement.
- Seldom use cash accounts (securities only).
While pattern day trading can double the amount of equities you can hold compared to a standard margin account, it can also inflate your risk. If no longer wish to be considered a pattern day trader, you can contact your brokerage and see about changing your status.
Pattern day trading can be an extensive and exhaustive job. For some people, however, it’s a great way to earn more money on their investments.
Due to the rules and regulations set in place, pattern day trading isn’t for everyone. It is set up to make sure certain types of investors take advantage of it. If you have the right amount of money and want to elevate to pattern day trading, it might be time to make the change.
But if you like the idea of making methodical decisions at a slower pace than day trading, or don’t necessarily have the capital to start pattern day trading, you may want to consider staying put or other investment options.
This Article appeared in SmartAssetBlog.