The Pattern Day Trading Rule Explained

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Narrator: Day trading means entering and exiting a position in a security within the same day. Day traders often use margin, or money borrowed from a brokerage, to increase leverage. While this could potentially increase profits, it can also lead to significant losses.

To help protect novice investors from large losses, in 2001, the Financial Industry Regulatory Authority, or FINRA, created the pattern day trader, or PDT, rule. Under the PDT rule, any margin account that executes four or more day trades in a five-market-day period is flagged as a pattern day trader. Getting flagged isn't necessarily bad; it just puts the account under a little more scrutiny. Once your account is flagged as a pattern day trading account, you're required to maintain a minimum of $25,000 of equity in that account in order to day trade securities.

Flagged accounts below this equity level can face restrictions, so it's important to understand what counts as a day trade and what happens to your account once you're classified as a pattern day trader.

So, what counts as a day trade?

Under the PDT rule, a day trade is the purchase and sale, or sale and purchase, of the same security in a margin account within a single trading day, sometimes called a "round trip". It applies to both long and short trades and includes pre- and post-market trading.

The key to determining what counts as a day trade is matching buy and sell orders. For example, let's assume your account has no trades at the beginning of the day. Then, you buy to open 100 shares, which means you purchase 100 shares to open a new position. Later, you add another 100 shares. And then, you buy 100 more shares, for a total of 300 shares. Later that day, you enter an order to sell to close those 300 shares. Despite there being three buy orders, there's only one exit order. This means there's only one pair of matching entry and exit orders, so it's only one day trade.

The opposite is also true. If you buy to open 300 shares and sell them off in three separate orders throughout the day, it'd still only be one day trade because there's only one buy order.

However, there are some exceptions when buy and sell orders in the same day may not match and thus don't count as a day trade. This can happen if you're closing an existing position that was opened during a previous trading day. For example, let's say you already own 100 shares of a stock. When the market opens, you sell to close 100 shares. Later, you decide to buy to open 100 shares. You have one sell order and one buy order in the same day, but it doesn't count as a day trade because the first sell to close matched with a buy order from a previous day, so it cannot match with the buy order in the current day.

To help keep track of your day trades, refer to the Account Info window on the thinkorswim^_® trading platform. But it's important to understand what happens if you surpass the allowed number of day trades. An account that's flagged as a pattern day trading account and has less than $25,000 in equity will receive a Day Trade Minimum Equity Call, or Equity Maintenance Call. You aren't required to immediately meet this call with funding, but if you place any more day trades while under the call, your account will be restricted to closing transactions only. This means you can close existing positions but can't open any new ones. The Equity Maintenance Call ends when either you bring the account equity above $25,000, or the PDT flag is removed from the account. A pattern day trading flag can only be removed one time from your account. If the account is later reflagged as PDT, the flag will remain on the account.

Remember that the $25,000 equity balance is the key. If you don't meet that requirement, you won't be allowed to day trade consistently. If you're concerned about being flagged as a pattern day trader, make sure you have a plan. Predetermine your entries and exits, and track when you place trades, so you know when you've hit your limit. Understanding and following PDT rules can help you avoid restrictions on your account.

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