The Pattern Day Trader (PDT) Rule: Key Takeaways
- The PDT rule is a nemesis of new traders — but it’s not the real danger…
- Day trading under the PDT can still be a good strategy if you know this first step…
- Learn my favorite afternoon pattern to cut down on your PDT worries…
Avoid the PDT by cutting down on random trades with our weekly watchlist!
If you hate the pattern day trader (PDT) rule, you’re not alone. It started as a way to protect ‘unsophisticated investors’ … Yes, that’s the official term.
Many see the PDT rule as a major barrier to entry. What’s a newbie trader to do?
Read on to learn what you’re dealing with as a trader under the PDT — and how to safely trade around it.
Table of Contents
- 1 Pattern Day Trader Rule
- 2 What Is Day Trading?
- 3 What Is a Pattern Day Trader (PDT) According to FINRA?
- 4 Day Trading Pro Tip: Open More Than One Trading Account
- 5 Want to Learn to Day Trade Like a Pro?
- 6 Conclusion
- 7 One Platform. One System. Every Tool
Pattern Day Trader Rule
The government regulator, FINRA, introduced the PDT rule to keep low-net-worth traders ‘safe.’
Like many things that started as good ideas, it has some unintended consequences.
First, let’s talk about exactly what you’re dealing with…
What Is Day Trading?
Maybe you’re a small-account trader. That’s OK. We all have to start somewhere.
Having a small account means that long-term investing is less attractive than trading…
A 10% return is good for an investment. But it won’t mean much if you start out with $1,000.
Day trading can bring those types of returns within hours or minutes!
It can also lead to big losses. That’s what FINRA wanted to stop when it created the PDT rule in 2001…
When online brokers came on the scene, day trading became MUCH easier to do. People didn’t understand how fast they could blow up their accounts.
Some still don’t.
When you short a day 1 low floater, are briefly up 2 cents a share, then blow up your account. $OCGN #riskmanagement pic.twitter.com/CYjGS41JYv— Timothy C. Bohen 🇺🇸 (@tbohen) October 9, 2019
Why Day Trade?
Day trading can be a good strategy for locking in quick gains. A quality catalyst can bump stock prices up A LOT.
The company might not hold onto those gains. Day trading helps traders safeguard gains that don’t become part of a stock’s longer-term value.
Day Trade Examples
When you open and close a position over a single trading day, that’s considered a day trade.
Simple right? Not so fast.
Traders get into trouble when they don’t count their day trades the same way FINRA does. Here are some examples of what counts as an ‘official’ day trade:
- Example 1: If you buy or short sell 100 shares of Stock X and exit your position the same day, you just day traded.
- Example 2: What about opening a 100-share position in Stock X and exiting half the position on the same day? It still counts as one day trade even though you didn’t exit all of your shares.
- Example 3: You buy or short sell 50 shares of Stock X at 9.45 a.m. Eastern, add another 50 shares at 10.15, then add 100 more shares at 11:00. You unload all 200 shares at 02.30 p.m. the same day. You have just made three day trades.
You can see how it gets tricky. This is especially true if you’re trading without a plan.
Read more about day trading here.
What Happens If You Hold a Stock Overnight?
If you stay in a position overnight, it won’t count as a day trade.
Overnighting a stock can seem pretty attractive when you’re approaching your weekly limit under the PDT.
It’s only a smart strategy if it matches your trading plan. If you hold onto a stock that doesn’t match your plan, you’re risking more than you should.
Staying in a trade that’s going against you is one of the unintended consequences of the PDT.
There’s another scenario — one that takes advantage of a multi-day trend. This is called swing trading, and it can be a good strategy for traders under the PDT.
Swing Trade Example
Short-term positions that last more than one day are called swing trades. Unlike day trades, they don’t have an official definition.
Swing trades can last for as little as two trading days. That’s good news for fans of my favorite afternoon pattern — the VWAP-hold, high-of-day break.
This pattern checks a lot of boxes. Here are the indicators you should look for approaching the 2 p.m. Eastern window:
- Former runner
- Hot sector
- Low float
- Unusual volume
- Up at least 10% for the day
- Holding VWAP
A stock that checks all of these boxes might be headed for its next leg up. Trading volume usually picks up after lunch, around 2 p.m., give or take.
What I look for with this pattern is a stock that’s at or near its high of the day. If it can hold this level until the market close, it has a good chance of gapping up overnight.
If you exit a trade like this the next morning, it won’t count against your allotment of day trades.
Like any pattern, this one doesn’t always work. That means that you always need to define your risk.
That’s another thing I like about this pattern. It gives you a clear risk to work with. If the stock falls below VWAP, it’s time to cut your losses — which will count as a day trade.
Learn more about swing trading here.
Now we need to talk about what small-account traders are up against.
What Is a Pattern Day Trader (PDT) According to FINRA?
By FINRA’s definition, a pattern day trader has to check three boxes:
- They’re trading on margin
- They trade more than three times in a rolling five-day period
- Their day trades constitute over 6% of their total trades in the same five-day period
Let’s skip over the piece where FINRA or your broker flags you as a day trader even if you don’t check these boxes…
(This might include specialized day trader training … Make sure you speak with your broker if you think you might be caught in the PDT’s wide net.)
Here’s what the PDT designation looks like for most traders.
How Traders Get Flagged Under the PDT Rule
Most small-account traders can ignore the last part of the PDT rule.
If you make more than three day trades in a five-day period … but they’re less than 6% of your overall trades?
Then you’re overtrading in a BAD way. That would come out to about 16 non-day trades for every day trade!
The three-trade limit is what you have to watch out for.
Let’s say you make one day trade on Wednesday, another on Thursday, and a third on Friday.
You’ll have to wait till the next Wednesday to make another day trade.
The clock is still running on those Thursday and Friday trades though. You only get all three day trades back five trading days after the last of the three is complete.
What Happens if You’re Classified as a Pattern Day Trader?
The minimum equity requirement for trading as a pattern day trader is $25,000. If you have $24,999 or less in your trading account, you can trigger the PDT rule.
If you get hit with the PDT, some bad things can happen:
- You can get locked into holding a trade overnight. This can be a bad thing if the trade goes against you before the market close
- And you can get hit with a margin call
The second PDT violation is the bad one. It results in having your margin account frozen for 90 days.
So how can you avoid getting classified as a pattern day trader?
Day Trading Pro Tip: Open More Than One Trading Account
There’s no rule against opening accounts with multiple brokerages.
This will let you make three day trades in each account within a given five-day period.
Day Trading With Two Accounts: What You Must Know
This isn’t against the law, but it can definitely get complicated.
You always need to check fees and conditions with your broker. Double up on brokers and you give yourself double the work — at least.
Want to Learn to Day Trade Like a Pro?
Learning to build good trading plans should be the first step in any strategy. Luckily, this is what we do every day on the SteadyTrade Team.
Every morning and afternoon, I break down potential trades and discuss trading plans. This mentorship program was designed with traders under the PDT in mind.
Apply to become a member of the SteadyTrade Team here!
The PDT is a boogeyman for new traders…
For me, it’s just another rule to follow. And it isn’t the most important one.
As a new trader, you should be more concerned with process than profit. So get that $25,000 figure out of your head.
Learn to trade the right way first. Getting over the PDT should be another milestone on the way to your bigger goals!
Feeling better about the PDT rule? Still have questions? Let me know in the comments!
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