How Long Do You Have to Hold a Stock to Avoid Day Trading?

Active participation in the stock market offers opportunities for gains through frequent buying and selling of securities. However, active traders must navigate specific regulatory rules designed to manage market risk and protect investors. Understanding these rules is important for anyone considering an active trading approach, as they dictate certain account requirements and trading limitations.

Defining a Pattern Day Trader

A “Pattern Day Trader” (PDT) is a designation established by regulatory bodies, such as the Financial Industry Regulatory Authority (FINRA), under FINRA Rule 4210. An individual is classified as a pattern day trader if they complete four or more “day trades” within any five consecutive business days. These day trades must also constitute more than six percent of the customer’s total trading activity during that same five-business-day period.

A “day trade” occurs when an investor opens and then closes a position in the same security within the same trading day. This includes purchasing and selling a security, or selling short and then buying to cover it, all within a single trading session. For example, if an investor buys 100 shares of a stock at 10:00 AM and sells them at 2:00 PM on the same day, that counts as one day trade. If shares are bought on one day and sold the following business day, this transaction does not count as a day trade.

The rules apply to trading across various securities, including stocks and options, when conducted within a margin account. For example, buying and selling shares of XYZ company, then buying and selling options on XYZ company, all on the same day, would count as two separate day trades. Brokerage firms track this activity and designate accounts as pattern day traders based on these criteria.

Understanding Pattern Day Trader Consequences

Being designated a Pattern Day Trader carries specific financial and account requirements. The primary consequence is the need to maintain a minimum equity balance of $25,000 in the brokerage account on any day day trading activity occurs. This required minimum equity can be a combination of cash and eligible securities, and must be present in the account before engaging in any day trading.

Should an account’s equity fall below this $25,000 threshold, the pattern day trader will face trading restrictions. The brokerage firm will issue a “day trading margin call,” requiring the investor to deposit additional funds or securities to bring the account back to the $25,000 minimum. If this margin call is not met by the specified deadline, typically within five business days, the account’s day trading capabilities will be significantly limited.

An account that fails to meet a day trading margin call may be restricted to trading only on a “cash available basis” for 90 days, or until the call is fully met. The funds deposited to meet a day trading margin call or the minimum equity requirement must remain in the account for two business days following the deposit.

Strategies for Avoiding Pattern Day Trader Status

A fundamental strategy for investors seeking to avoid the Pattern Day Trader designation involves adjusting the timing of their trades. The most direct method is to hold a security for at least one night, meaning the position is opened on one trading day and closed on a subsequent trading day. This ensures the transaction is not classified as a “day trade,” and therefore does not contribute to the four-trade-in-five-days threshold.

Another practical approach is to meticulously track the number of day trades executed within the rolling five-business-day period. Investors can use brokerage statements or internal tracking systems to monitor their trading frequency. Staying aware of the number of day trades completed allows an investor to consciously limit their activity to fewer than four day trades within the five-day window, thereby avoiding the PDT classification.

For those who wish to maintain higher trading frequency without meeting the PDT requirements, alternative account structures can be considered. Using multiple brokerage accounts might allow for the distribution of day trades across different accounts, provided each account is managed independently and adheres to its own rules. Additionally, trading through a cash account offers different rules regarding frequent trading, distinct from those governing margin accounts.

Distinctions Between Cash and Margin Accounts

The regulatory framework for frequent trading, particularly the Pattern Day Trader rule, primarily applies to margin accounts. Cash accounts operate under different regulations regarding the availability of funds for trading. A key concept in cash accounts is “settled funds,” which refers to money that has completed the clearing process from a sale of securities. For most stock trades, funds settle on a “trade date plus one business day” (T+1) basis.

In a cash account, purchasing and then selling a security before the funds from the initial purchase have settled can lead to a “good faith violation” (GFV). This occurs if an investor uses unsettled proceeds from a prior sale to buy new securities, then sells those new securities before the original funds have fully settled. For example, if an investor sells stock A on Monday (funds settle Tuesday) and uses those unsettled funds to buy stock B on Monday, then sells stock B on Monday, a GFV occurs. Accumulating multiple good faith violations, typically three within a rolling 12-month period, can result in the account being restricted to trading only with settled funds for 90 days.

Another related issue in cash accounts is a “free-riding violation.” This occurs when an investor buys securities without sufficient funds in the account, then sells those securities before depositing the necessary funds to cover the purchase. A single free-riding violation can lead to a 90-day restriction, limiting the account to trading only with settled cash. While cash accounts avoid the PDT designation, they impose their own restrictions tied to fund settlement, which can significantly impact trading flexibility.