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What is a pattern day trader? Pattern day trader rule workaround

 

What is a pattern day trader



What is a pattern day trader?


Day trading means entering and exiting a position in a security within the same day. Day traders often use margin, or money borrowed from a brokerage, to increase leverage. While this can potentially increase profits, it can also lead to significant losses. 

To help protect novice investors from large losses, in 2001, the Financial Industry Regulatory Authority, or FINRA, created the pattern day trader, or PDT, rule. 

Under the rule, any margin account that executes four or more day trades within any rolling five-business-day period is flagged as a pattern day trader. Getting flagged isn’t necessarily bad; it just puts the account under a little more scrutiny. 

Once your account is flagged as a day trading account, you’re required to maintain a minimum of $25,000 of equity in that account. Flagged accounts below this equity level can face restrictions, so it’s important to understand what counts as a day trade and what happens to your account once you’re classified as a pattern day trader. 

So, what counts as a day trade? Under the PDT rule, a day trade is a complete entry and exit of a stock, options, or ETF position within a single trading day, sometimes called a round trip. It applies to both long and short trades and includes pre-and postmarket trading. 

The key to determining what counts as a day trade is matching buy and sell orders. For example, let’s assume your account has no trades at the beginning of the day. Then you buy to open 100 shares, which means you purchase 100 shares to open a new position. 

Later, you add another 100 shares. And then you buy 100 more shares, for a total of 300 shares. Later that day, you enter an order to sell to close those 300 shares. Despite there being three buy orders, there’s only one exit order. 

This means there’s only one pair of matching entry and exit orders, so it’s only one day trade. The opposite is also true. If you buy to open 300 shares and sell them off in three separate orders throughout the day, it’d still only be one day trade because there’s only one buy order. 

You also need to be careful mixing long and short trades. Imagine you buy to open 100 shares and follow it up with another buy to open for 100 shares. Then the stock turns bearish, so you sell your 200 shares. This counts as one day trade. 

Then you decide to short the same falling stock, so you sell to open 100 shares. Even though the second sell order is opening a new short position, it counts as a second-day trade because it matches with one of the two earlier buy orders. 

However, there are some exceptions when buy and sell orders in the same day may not match and thus don’t count as a day trade. This can happen if you’re closing an existing position that was opened during a previous trading day. 

For example, let’s say you already own 100 shares of stock. When the market opens, you sell to close 100 shares. 

Later, you decide to buy to open 100 shares. You have one sell order and one buy order on the same day, but it doesn’t count as a day trade because the first sell to close matched with a buy order from a previous day, so it cannot match with the buy order in the current day. 

However, existing positions don’t mean you’re free and clear. Let’s say you started the day with 200 shares of stock. That morning you place two buy orders for 100 shares each. Later that day, you sell 200 shares and then sell another 200 shares. 

This counts as two-day trades because you added to the existing position before closing it, leaving you with two pairs of matching buy and sell orders on the same day. TD Ameritrade.com has alerts that can help you track your day trades, and the thinkorswim® platform counts them for you in the Account Info window. 

But it’s important to understand what happens if you surpass the allowed number of day trades. An account that’s flagged as a pattern day trading account and has less than $25,000 in equity will receive a Day Trade Minimum Equity Call or Equity Maintenance Call. 

You aren’t required to immediately meet this call with funding, but if you place any more day trades while under the call, your account will be restricted to closing transactions only. This means you can close existing positions but can’t open any new ones. 

The Equity Maintenance Call ends when either you bring the account equity above $25,000, or the PDT flag is removed from the account. A pattern day trading flag can only be removed one time from your account. Remember that the $25,000 equity balance is the key. 

If you don’t meet that requirement, you won’t be allowed to day trade consistently. If you’re concerned about being flagged as a pattern day trader, make sure you have a plan. 

Predetermine your entries and exits, and track when you place trades so you know when you’ve hit your limit. Understanding and following pattern day trading rules can help you avoid restrictions on your account. 


Also read: How to Identify Stock Trend Changes 

Also read: How many types of mutual funds are there in india 

Also read: How to Build a Portfolio with ETFs

Also read: How to invest for retirement at age 60


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