How Many Day Trades Before Being a Pattern Day Trader?

Day trading involves the frequent buying and selling of securities within the same trading day. This strategy aims to profit from small, short-term price movements in the market. While it can offer opportunities for quick gains, day trading also carries significant risks, including the potential for substantial losses. For individual investors, understanding specific regulatory guidelines, particularly those related to the “Pattern Day Trader” rule, is important before engaging in such activities.

Defining Day Trading and Pattern Day Traders

A “day trade” is defined by the Financial Industry Regulatory Authority (FINRA) as the purchase and sale, or the sale and purchase, of the same security on the same day within a margin account. This definition applies broadly to various securities, including options. For instance, if an investor buys 100 shares of a stock at 10:00 AM and sells those same 100 shares at 2:00 PM on the same day, that constitutes one day trade. Similarly, selling a security short and then buying it back to cover the position within the same trading day also counts as a day trade.

The “Pattern Day Trader” (PDT) designation is a regulatory classification for investors who execute a specific volume of day trades. An individual is labeled a Pattern Day Trader if they complete four or more day trades within any five consecutive business days. This classification applies only to activities conducted within a margin account.

The four or more day trades must also represent more than six percent of the customer’s total trading activity in the margin account during that same five-business-day period. Brokers can also designate a customer as a Pattern Day Trader if they have a reasonable belief that the customer intends to engage in pattern day trading.

Trades that do not count as day trades include purchasing a security and holding it overnight before selling it the next day, or selling a security that was held overnight and buying it back the next day. A single purchase followed by multiple sales of that same position on the same day still counts as only one day trade. Conversely, multiple purchases of a security followed by a single sale of the entire position on the same day also constitutes just one day trade. This emphasis is on the “round trip” of a security within a single trading session.

Understanding the Pattern Day Trader Rule

The core framework governing Pattern Day Traders is established by Financial Industry Regulatory Authority (FINRA) Rule 4210, which outlines specific margin requirements for brokerage accounts. This rule is designed to ensure that individuals engaging in frequent day trading activities possess sufficient capital to mitigate the inherent risks. It stipulates that any customer designated as a Pattern Day Trader must maintain a minimum equity of $25,000 in their margin account.

This $25,000 minimum equity is a prerequisite; it must be present in the account before any day trading activity commences on a given day. The required equity can consist of a combination of cash and eligible securities, providing flexibility in how traders meet this threshold. This requirement serves as a buffer, offering a financial cushion to both the trader and the brokerage firm against potential losses that can arise from rapid, unsettled transactions.

If an account’s equity falls below the $25,000 threshold, Pattern Day Traders are immediately restricted from further day trading. This restriction remains in effect until the account’s equity is restored to at least $25,000. To meet this requirement, funds or eligible securities must be deposited, and these funds need to remain in the account for at least two business days following the deposit.

Beyond the minimum equity, the rule also defines a Pattern Day Trader’s “day trading buying power.” This refers to the maximum dollar amount of securities a Pattern Day Trader can purchase and sell within the same day. This buying power is calculated based on the account’s maintenance margin excess. Each day trading account must independently meet all margin requirements; cross-guarantees across separate accounts are not permitted.

Consequences of Pattern Day Trader Classification

Being classified as a Pattern Day Trader has implications if the account does not meet equity requirements or if trading activity exceeds limits. If a Pattern Day Trader uses more than their allotted day-trading buying power, the brokerage firm will issue a day-trading margin call, demanding additional funds to bring the account back into compliance.

Upon receiving a day-trading margin call, the trader has up to five business days to deposit the necessary funds. During this period, the account’s day-trading buying power will be significantly curtailed. This immediate reduction in buying power restricts the volume and frequency of new day trades that can be initiated.

Failure to meet the day-trading margin call within the specified five-business-day timeframe leads to more severe restrictions. The account will be limited to trading on a cash-available basis for a period of 90 calendar days, or until the call is fully satisfied. This means the trader can only engage in transactions using fully settled cash, effectively preventing the use of margin for day trading. In some cases, the account may be placed on a “closing-only” status, allowing the trader to sell existing positions but prohibiting the opening of any new trades.

Funds deposited to satisfy a margin call or to restore the account to the $25,000 minimum equity requirement must remain in the account for at least two business days. Once an account is flagged as a Pattern Day Trader, some brokerage firms may maintain this designation even if the trader temporarily ceases day trading, based on the firm’s reasonable belief of the trader’s intent.

Day Trading with Different Account Types

The application of day trading rules and the Pattern Day Trader (PDT) designation varies by account type. While the PDT rule, with its $25,000 minimum equity requirement, primarily applies to margin accounts, day trading in a cash account operates under a different set of constraints.

A cash account requires that all securities purchases be paid for in full with funds that have already settled. Unlike margin accounts, cash accounts do not permit borrowing funds from the brokerage firm, eliminating margin calls or the $25,000 PDT minimum.

Day trading in a cash account is limited by settlement periods. The standard settlement cycle for most stock transactions is T+1 (trade date plus one business day). Funds from the sale of a security become available for reinvestment on the next business day. For instance, if a trader uses all their available cash to buy a stock on Monday and sells it the same day, the proceeds from that sale will not be available for another purchase until Tuesday.

Attempting to buy a security with unsettled funds and then selling it before those funds have settled can lead to a “Good Faith Violation” (GFV). A related concept is “free riding,” which refers to buying and selling a security without ever having the necessary funds in the account to cover the initial purchase.

Incurring multiple Good Faith Violations or a free riding violation can result in restrictions on the cash account. A brokerage firm may restrict an account for 90 days, allowing trades only with fully settled cash. This means that any funds used for a purchase must be physically present and settled in the account before the trade is executed, severely limiting the ability to day trade using recycled capital.