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Most traders trade on borrowed money, and when they lose while trading and can’t pay up, it leaves the broker on the hook and can affect the financial system.
To minimize these situations, the Financial Industry Regulatory Authority (FINRA) issues several rules, and requirements traders must meet to continue trading.
One of those rules is the “pattern day trading” or PTD rule, which sets account minimum and margin requirements for day traders.
The U.S. Financial Industry Regulatory Authority (FINRA) established the “pattern day Trader rule.” The rule states that if a stock trader or investor executes four or more day trades in a five business days period, the trader is considered a pattern day trader and must maintain a $25,000 minimum balance unless the trades constitute 6% or less of the margin account trade during the five days.
According to Rule 2520, which stipulates the bare minimum equity requirement; If the total equity drops below the threshold of $25,000 (a combination of cash and specific securities), a pattern day trader won’t be able to complete any trade until it’s back up to $25,000 or above’. This rule was passed in 2001 by the Security and Exchange Commission as an amendment to the NASD.
On the case of a margin call, the day trader will have five days to answer it (pay up the balance). Trading activities within this period will be limited to two times the maintenance margin. Failure to meet up the call will cause the account to be frozen for 90 days or until a period when the person can respond to resolve the issue.
A non-day trader can also turn to a pattern day trader anytime the stipulated criteria are met. Similarly, if a trader wishes to open an account to engage in pattern day trading, then the broker can consider them a day trader without waiting for the five days.
The rule set by the FINRA is the minimum requirements. Brokerages can set specific requirements for account size and minimum balance.
The PTD rule provides day trading power up to 4 times the maintenance margin excess. So, for example, if a day trader has $50,000 with no margin loan, then the leverage will be 4:1.
This means the trader can buy up to $200,000 worth of securities.
Many people see the pattern day trading rule as a barrier in trading activities. Other even go a step further to ensure they never fall under the PTD criteria.
Here are some ways you can beat the rule to avoid being declared a day trader.
Conclusively, trading on margin can be risky, and the PDT rule is stricter to reflect the risk of day trading.