The PTD rule, first implemented in 2001, protects day traders by limiting their exposure to the hazards associated with day trading. Executing positions using margin for more than five days in a row is a violation of the rule, and the SEC can take action against traders who do so. The restriction can prevent you from opening new positions if you qualify as a pattern day trader and your account balance is less than $25,000 at the time.
A day trade is when a security is purchased or shorted, and the same is sold or covered on the same day.
Risk-averse traders should stay away from the market if they are short on cash and lack experience. In essence, a day trader must be ready to lose all of the money they have invested in the trade.
Who is a pattern day trader?
Once your funds meet the PTD threshold, you must hold at least $ 25,000 in equity. This will give you greater purchasing power. Day traders have it 4 to 1, double that of non-day traders’ power. This is to ensure you cannot hold power overnight and utilize it during the day.
How does the PDT rule work?
To avoid a minimum equity call, which requires a deposit of $25,000, certain brokerage firms need that you make four-day trades in a rolling five-day period.
Traders can only carry out three-day trades once every rolling five days if they have $5,000 or less. If your balance reaches $25,000 or more, the restriction does not apply to you.
To figure out your true equity, you may need to deduct your maintenance margin from your trade equity, including cash and unrealized returns. You may be breaking the law if you engage in any PTD if your balance worth falls below $25,000
Your broker will generally alert you to avoid breaching these regulations by accident. They’ll put a 90-day hold on your money if you don’t heed their warnings.
The regulatory guidelines on flag removals are limited in application. If you follow the correct procedure, you may succeed in petitioning to remove the flag from your funds. You may see the reactivation of the flag on your account if your future behavior falls under the definition of PTD. You cannot delete the flag.
The impact of margin
Regular leveraged accounts have a $2,000 minimum opening balance. If the client is deemed a “pattern day trader,” the minimum investment rises to $25,000.
Day traders who fail to meet the day margin requirements have the same repercussions as those who do not meet the criteria for their regular accounts. You’ll get a day trade call if you open trades for more than your day trading purchasing power and then exit the market the same day.
When a deposit is due, you must hold onto your funds for at least two business days after the day’s closing to meet the day equity or margin call requirements. Brokers must also classify each client who engages in PTD in accordance with the law.
How to get around the rule
- Multiple brokerages: It’s a logical option to have many accounts open. Brokers in the United States have abolished commissions, making it possible for even small investors to maintain a presence on numerous exchanges. This strategy was previously challenging to adopt for traders having small capital.
- Those meager commissions ate up a lot of your earnings when you had a small fund to begin with. You can now open multiple $100 accounts with different brokers because you no longer have to worry about commissions. In five days, each extra account gives you additional three-day trades.
- Keep track of your trades: There are many ways investors might keep track of how many daily transactions they make in a rolling five-day period. Any purchase or sale made during the premarket or after-market trading hours qualifies as a day trade, so keep that in mind. Multiple positions within a day can also result from brokers’ trading styles who cannot execute a large order without breaking it down into smaller orders.
- You can also make sure you have $25,000 the night before you plan to make your fourth-day transaction in a five-day window.
The approaches above are generally easy to execute and also legal. However, it’s essential to remember that the PDT rule is designed to safeguard investors from excessive risk-taking. Taking your time while making investment decisions can work to your advantage.
As long as you can avoid breaking the restrictions or just keep your funds well above $25,000, you should have less to worry about when it comes to executing an intraday trade. Fortunately, commission-free trading has become more common among large discount brokers, making this rule more bearable.