What Happens If You Are Flagged as a Day Trader?

Day trading involves the frequent buying and selling of securities within a single trading day, offering potential for quick gains. This activity operates under specific regulations designed to protect investors and maintain market stability. This article explores the implications when a trader’s activity triggers regulatory flags related to frequent trading patterns.

Understanding Day Trading Rules

A “day trade” is generally defined as the purchasing and selling, or selling and purchasing, of the same security within the same trading day in a margin account. This definition applies to various securities, including stocks and options. The Financial Industry Regulatory Authority (FINRA) established specific guidelines for frequent trading through Rule 4210, known as the Pattern Day Trader (PDT) rule. This rule primarily applies to margin accounts, not cash accounts, due to the inherent risks associated with leveraged trading.

Under FINRA Rule 4210, an individual is identified as a “Pattern Day Trader” if they execute four or more day trades within any five consecutive business days. This classification also requires that the number of day trades represents more than six percent of the customer’s total trading activity within that same five-business-day period. Brokerage firms are also empowered to designate a customer as a PDT if they have a reasonable basis to believe the client will engage in pattern day trading. Once designated, this classification is typically permanent for that account, though some brokers may offer a one-time removal in specific cases.

A significant requirement for Pattern Day Traders is the maintenance of a minimum equity of $25,000 in their margin account. This equity, which can be a combination of cash and eligible securities, must be present in the account before engaging in any day-trading activities. If the account’s equity falls below this $25,000 threshold, the Pattern Day Trader is prohibited from day trading until the account is restored to the minimum equity level. The $25,000 minimum equity requirement provides a financial cushion to cover potential losses from rapid, leveraged transactions.

Consequences of Being Flagged

When a brokerage firm flags an account as a Pattern Day Trader and the account’s equity falls below the $25,000 minimum requirement, immediate repercussions follow. If a Pattern Day Trader exceeds their day-trading buying power, a “day-trading margin call” will be issued by the firm. The trader then has a limited period, typically up to five business days, to deposit additional funds to meet this margin call.

Until the day trading margin call is met, the account’s day trading buying power will be restricted. If the call is not met by the deadline, the account will be further restricted to trading only on a cash available basis for a period of 90 days. This 90-day restriction means the account will be limited to “liquidating-transactions only,” where the trader can sell existing positions but cannot open new day trades.

Brokerage firms enforce these restrictions to comply with regulatory requirements and mitigate their own risk exposure. If a trader fails to meet a day trading margin call, the broker may take actions that include limiting trading to liquidation-only status, or even forcing the liquidation of positions. Any funds deposited to meet the minimum equity requirement or a day-trading margin call must remain in the account for at least two business days following the close of business on the day the deposit is required.

Managing Your Trading Activity

Traders can proactively manage their activity to avoid being flagged as a Pattern Day Trader. A primary strategy involves carefully tracking the number of day trades executed within any five-business-day period. Limiting day trades to three or fewer within this rolling window can prevent the PDT designation. Maintaining account equity consistently above the $25,000 threshold is also a fundamental preventative measure.

Understanding the implications of trading in a cash account versus a margin account is another important aspect of managing trading activity. While cash accounts are not subject to the Pattern Day Trader rule, they are subject to “good faith violation” rules related to unsettled funds. A good faith violation occurs when a trader buys a security with unsettled funds and then sells it before the initial purchase has been fully paid for with settled funds. For example, if funds from a stock sale on Monday (settling Tuesday, T+1) are used to buy another stock on Monday, and that second stock is sold on Tuesday before the first sale has settled, a good faith violation can occur.

Incurring three good faith violations within a 12-month period can lead to a 90-day restriction on the cash account. During this period, the account will be limited to purchasing securities only with fully settled cash. This effectively limits day trading in a cash account, as funds from a sale are typically not settled until one business day after the trade date. Therefore, while cash accounts avoid PDT rules, they introduce their own set of restrictions that can impede frequent trading if not carefully managed.

Restoring Trading Privileges

If an account has been flagged and restricted due to a day trading margin call or falling below the minimum equity requirement, there are specific steps a trader can take to restore trading privileges. The primary method for resolving a day trading margin call is to deposit additional funds. These funds must bring the account equity back above the $25,000 minimum threshold. Any funds deposited to meet such a call must remain in the account for at least two business days following the close of business on the day the deposit is required.

Some brokerage firms offer a “day trading reset” option, which can remove the Pattern Day Trader designation. This feature is typically a one-time option per 180 days or per account lifetime, depending on the broker’s policy. To request a reset, traders usually need to contact their brokerage firm directly or utilize a specific tool provided by the broker. It is important to note that if a reset is processed, any day trades made on the same day may not be removed and could lead to immediate re-classification as a Pattern Day Trader.

An alternative to meeting the margin call or requesting a reset is simply waiting out the 90-day restriction period. After this period, if the call has not been met, the account restriction may be lifted, though any outstanding equity maintenance calls would remain until satisfied. Direct communication with the brokerage firm is important to understand their specific policies and procedures for lifting restrictions. Brokers can provide guidance on the exact requirements and timelines for regaining full trading privileges, ensuring compliance with their internal rules and regulatory mandates.