What Is a Pattern Day Trader (PDT)?
A pattern day trader (PDT) is a regulatory designation for those traders or investors that execute four or more day trades over the span of five business days using 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.
If this occurs, the trader's account will be flagged as a PDT by their broker. The PDT designation places certain restrictions on further trading; this designation is put in place to discourage investors from trading excessively.
- A pattern day trader (PDT) is a trader who executes four or more day trades within five business days using the same account.
- Pattern day trading is automatically identified by one's broker and PDTs are subject to additional regulatory scrutiny and limitations.
- 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.
Understanding Pattern Day Traders
Pattern day traders may trade different types of securities, including stock options and short sales. Any type of trade will be accounted for, in terms of this designation, as long as they occur on the same day.
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.
Regulations That Govern Pattern Day Traders (PDTs)
The PDT designation is determined by the Financial Industry Regulatory Authority (FINRA); it 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, at this point they will be prohibited from making any further day trades until the balance is brought back up.
FINRA has established a PDT rule that requires that all PDTs 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 cash equity in the account drops below this $25,000 threshold, the PDT 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. 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.
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 1% 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 2% 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.