What is a Pattern Day Trader?
A pattern day trader is a regulatory designation for traders or investors that execute four or more day trades during five business days’ time and in a margin account. The number of day trades must constitute more than 6% of the margin account's total trade activity during that five-day window. The PDT designation is in place to discourage investors from trading excessively. FINRA requires that pattern day traders have a minimum of $25,000 in their brokerage accounts in a combination of cash and certain securities as a way of reducing risk. If the equity in the account drops below this $25,000 threshold, the pattern day trader can no longer complete any day trades until the account is back up above that point. This is known as the Pattern Day Trader Rule or the PDT Rule.
Basics of a Pattern Day Trader
A pattern day trader is a day trader who purchases and sells the same security on the same day in a margin account. Pattern day traders must also have more than six percent of those trades occur in the same margin account for the same period to be considered separate from a standard day trader. These securities can include stock options and short sales, as long as they occur on the same day.
The designation is determined by the Financial Industry Regulatory Authority (FINRA) and differs from that of a standard day trader by the amount of day trades completed in a time frame. Although both groups have mandatory minimum assets that must be held in their margin accounts, a pattern day trader must hold at least $25,000 in their account. That amount need not necessarily be cash; it can be a combination of cash and eligible securities. If the equity in the account drops below $25,000 they will be prohibited from making any further day trades until the balance is brought back up.
If there is a margin call, the pattern day trader will have five business days to answer it. Their trading will be restricted to that of two times the maintenance margin until the call has been met. Failing to address this issue after five business days will result in a 90-day cash restricted account status, or until such time that the issues have been resolved.
These rules are set forth as an industry standard, but individual brokerage firms may have stricter interpretations of them. They may also allow their investors to self-identify as day traders.
- A pattern day trader is a trader who executes four or more day trades within five business days using the same account.
- Pattern day traders are required to hold $25,000 in their margin accounts. If the account drops below $25,000 they will be prohibited from making any further day trades until the balance is brought back up.
Example of Pattern Day Trading Profits
Consider the case of Jessica Dunn, a day trader with $30,000 in assets in her margin account. She could be eligible to purchase up to $120,000 worth of stock, compared to the standard $60,000 for an average margin account holder. If her stocks gained one percent over the day, as a pattern day trader she could generate an estimated $1,200 profit, which equals a four percent gain.
Compare that to the standard estimated profit of $500, or two percent gain on a margin account. The potential for a higher return on investment can make the practice of pattern day trading seem appealing for high net worth individuals. However, like most practices that have the potential for high returns, the potential for significant losses can be even greater.