DEFINITION of 'Pattern Day Trader'

A regulatory designation for any traders that execute four or more “day trades” within five business days, provided that the number of day trades (buys and sells) represents more than six percent of the trader’s total trades in the margin account for that same period. The required minimum equity in an account is higher for a pattern-day trader than a non-pattern day trader. 

BREAKING DOWN 'Pattern Day Trader'

Day trades are defined by FINRA as, "the purchase and selling or the selling and purchasing of the same security on the same day in a margin account." The definition includes stock options and short sales that are covered on the same day.

The two exceptions to the rule are:

  • Long positions held overnight and sold the next day prior to new purchases of the same security.
  • Short positions held overnight and purchased the next day prior to any new sale of the same security.

What is a Pattern Day Trader?

A pattern day trader is any trader who executes four or more “day trades” within a five business day period, provided that the number of day trades (buys and sells) represents more than six percent of their total trades in the margin account, according to FINRA.

It’s important to note that FINRA’s definition of a pattern day trader is a minimum requirement and some broker-dealers may have broader definitions of what constitutes a pattern day trader. For example, broker-dealers may designate a trader as a pattern day trader if it has a reasonable basis for believing that a client will engage in pattern day trading (such as checking off a "day trading" box on an application form).

Traders should contact their brokerage firm to determine whether their trading activities will lead to a pattern day trader classification.

What It Means for Trading

FINRA requires that pattern day traders have at least $25,000 worth of equity in their accounts at all times and only trade on margin accounts. If the account falls below the $25,000 requirement, the trader cannot place any day trades until the equity is restored by depositing additional cash and/or securities into the account. Traders who fall under the pattern day trader classification should ensure that they’re well-capitalized enough to day trade.

The upshot is that pattern day traders may trade at up to four times their maintenance margin excess as of the close of business of the previous day, which is approximately double that of standard margin accounts for non-pattern day traders. Of course, leverage is a double-edged sword and traders should exercise caution when using it. Twice the leverage enables twice the gains, but also twice the losses for a given trade.

Example

Suppose that a pattern day trader has $30,000 in cash. They may be able to purchase up to $120,000 worth of stock compared just $60,000 for a typical margin account. If the stock gained 1% over the day, a pattern day trader could generate a hypothetical $1,200 profit – or a 4% gain – compared to just $600 in profit – or a 2% gain – for a margin account.

If a trader exceeds these margin requirements, the broker-dealer will issue a day trading margin call and the trader will have five business days to meet the margin call. The trader’s day trading buying power will be restricted to two times maintenance margin excess until the issue is addressed. A failure to address a margin call after five business days results in a cash restricted account status for 90 days or until the issue is resolved.

The Bottom Line

A pattern day trader is any trader who executes four or more “day trades” within five business days, provided that the number of day trades (buys and sells) represents more than six percent of the trader’s total trades in the margin account for that same period. There are both benefits and drawbacks to a pattern day trader designation that traders should carefully consider.

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