Pattern day trader is FINRA designation for a stock market trader who executes four or more day trades in five business days in a margin account , provided the number of day trades are more than six percent of the customer's total trading activity for that same five-day period. A pattern day trader is subject to special rules. The required minimum equity must be in the account prior to any daytrading activities.
Three months must pass without a day trade for a person so classified to lose the restrictions imposed on them. Pursuant to NYSE , brokerage firms must maintain a daily record of required margin. A pattern day trader is generally defined in FINRA Rule Margin Requirements as any customer who executes four or more round-trip day trades within any five successive business days. A non-pattern day trader i. If the brokerage firm knows, or reasonably believes a client who seeks to open or resume trading in an account will engage in pattern day trading, then the customer may immediately be deemed to be a pattern day trader without waiting five business days.
Day trading refers to buying and then selling or selling short and then buying back the same security on the same day. For example, if you buy the same stock in three trades on the same day, and sell them all in one trade, that can be considered one day trade  or three day trades.
Day trading also applies to trading in option contracts. Forced sales of securities through a margin call count towards the day trading calculation. Under the rules of NYSE and Financial Industry Regulatory Authority , a trader who is deemed to be exhibiting a pattern of day trading is subject to the "Pattern Day Trader" rules and restrictions and is treated differently than a trader that holds positions overnight. In order to day trade: The rule provides day trading buying power to up to 4 times a pattern day trader's maintenance margin excess.
The excess maintenance margin is the difference of the account equity and the margin requirement. If the account has a margin loan, the day trading buying power is equal to four times the difference of the account equity and the current margin requirement. If a client's day trading margin requirement is to be calculated based on the latter method, the brokerage must maintain adequate time and tick records documenting the sequence in which each day trade is completed.
Time and tick information provided by the customer is not acceptable. The Pattern Day Trading rule regulates the use of margin and is defined only for margin accounts. Cash accounts, by definition, do not borrow on margin, so day trading is subject to separate rules regarding Cash Accounts.
Cash account holders may still engage in certain day trades, as long as the activity does not result in free riding , which is the sale of securities bought with unsettled funds. An instance of free-riding will cause a cash account to be restricted for 90 days to purchasing securities with cash up front. During this day period, the investor must fully pay for any purchase on the date of the trade.
Requirements for the entry of day trading orders by means of "pattern day trader" amendments: While all investments have some inherent level of risk, day trading is considered by the SEC to have significantly higher risk than buy and hold strategies. The Securities and Exchange Commission SEC approved amendments to self-regulatory organization rules to address the intra-day risks associated with customers conducting day trading.
The rule amendments require that equity and maintenance margin be deposited and maintained in customer accounts that engage in a pattern of day trading in amounts sufficient to support the risks associated with such trading activities. In other words, the SEC uses the account size of the trader as a measure of the sophistication of the trader.
This rule essentially works to restrict less sophisticated traders from day trading by disabling the traders ability to continue to engage in day trading activities unless they have sufficient assets on deposit in the account. On the other hand, some argue that it is not problematic because it is some sort of unfair over-regulatory attack on the "free market," but because it is a rule that shuts out the vast majority of the American public from taking advantage of an excellent way to grow wealth.
Another argument made by opponents, is that the rule may, in some circumstances, increase a trader's risk. For example, a trader may use 3 day trades, and then enter a fourth position to hold overnight. If unexpected news causes the security to rapidly decrease in price, the trader is presented with two choices. One choice would be to continue to hold the stock overnight, and risk a large loss of capital. The other choice would be to close the position, protecting his capital, and perhaps inappropriately fall under the day-trading rule, as this would now be a 4th day trade within the period.
Of course, if the trader is aware of this well-known rule, he should not open the 4th position unless he or she intends to hold it overnight.
However, even trades made within the three trade limit the 4th being the one that would send the trader over the Pattern Day Trader threshold are arguably going to involve higher risk, as the trader has an incentive to hold longer than he or she might if they were afforded the freedom to exit a position and reenter at a later time. In this sense, a strong argument can be made that the rule inadvertently increases the trader's likelihood of incurring extra risk to make his trades "fit" within his or her allotted three-day trades per 5 days unless the investor has substantial capital.
The rule may also adversely affect position traders by preventing them from setting stops on the first day they enter positions. For example, a position trader may take four positions in four different stocks. To protect his capital, he may set stop orders on each position. Then if there is unexpected news that adversely affects the entire market, and all the stocks he has taken positions in rapidly decline in price, triggering the stop orders, the rule is triggered, as four day trades have occurred.
Therefore, the trader must choose between not diversifying and entering no more than three new positions on any given day limiting the diversification, which inherently increases their risk of losses or choose to pass on setting stop orders to avoid the above scenario. Such a decision may also increase the risk to higher levels than it would be present if the four trade rule were not being imposed.