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What you need to know about the PDT rule

InvestorEducation / Learn to Trade May 09, 2019 - 01:00 PM GMT

By: Submissions

InvestorEducation

One of the most ignored subjects in stock trading is the PDT rule. However, it is unimaginable how the rule can get you into trouble especially if you are not ready to meet the basic requirements.  In this article, we are going to break down what a PDT is and the rules that govern pattern day trading.


What is pattern day trading?

A pattern day trader is any stock trader who executes 4 or more day transactions within five days. This is provided that the amount of trade amounts to over 6% of the total margin account that the customer has traded on in the 5 business days.

It is however important to note that pattern day trader rules only apply to margin accounts. This means that only people trading on credit get affected by the rule. On the other hand, those who trade on a cash account are immune to this rule. However, if you trade with both cash and margin accounts the rules could apply if you meet the PDT threshold.  

Pattern day trader requirements

If you surpass the PDT threshold and be labeled as a PDT, there are some things that you need to know. Being a PDT is not a bad thing after all especially if you have the money to meet the floor. You however need to have about $25,000 in your brokerage account so that it can be used as a baseline security. However, the amount is required to remain above $25,000 or you risk having the account frozen. However, once you are operating a cash account, the threshold will not apply to you.  

The other part of a pattern day trader requirement is the trading deadline requirement. To be classified as a pattern day trader, you’re buying and selling of stock need to take place in the same business day. For example, if you buy in the morning and sell before the stock closes, then such transactions are considered as a day trade.  If you do this 4 times within a five day period, your margin account will fall under the pattern day trader rules. Therefore, you should be ready with your $25k to avoid this situation

On the other hand, it is important to note that both your gains and losses as a pattern day trader needs to exceed 6% of your total equity. This is to ensure that your profit or losses counts in your overall pattern day trade tally.

How to avoid being classified as a PDT

There are several ways of avoiding being classified as a PDT. First, if you complete two day trades in one, it is advisable to wait for another business day before continuing with your trade. Failure to do that will subject you to the PDT rule which will have adverse effects on your future stock trading endeavors.

Alternatively, you may consider getting cash account.  It is important to note that PDT rules only apply to those operating margin accounts. However, if you are not willing to push credit around, you could trade with a cash account and this will present you with a chance to avoid the PDT rule. And since your equity is cash, putting your account below the $25k mark will not subject you to the PDT rules. This means that, the account will not be frozen as is the case with a margin account.

If you still wish to continue with a margin account, there are other steps that you can take to avoid the pattern day trader rules. You should either try to extend your trades or stay within the 4 transactions limit. To be safe, you can easily do 3 trades within the week without triggering the $25k threshold.

What happens after you are labeled as a pattern day trader?

If you happen to be classified as a pattern day trader, there is some thing that you should open your mind to in order to close the restrictions. As a PDT, if you close a deal on the same day, you will have to wait for several days to access the physical funds. This is like depositing a check at the ATM when the branch has closed. And although you will still use the funds, you will have to wait longer for it to clear.

Conclusion

If you do not want to tie up over $25k in your margin account, you should really try to avoid the pattern day trader rule.  Tied money in your margin account will not be helpful as it cannot make you money. However, if you spread the timeline for completing transactions for a few weeks or months, you will be able to avoid the pattern day trader rule. With those wide timelines, you can complete your transactions without worrying that you will exceed the limits.

By Helen Bell

© 2019 Helen Bell - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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