What Is the Pattern Day Trader (PDT) Rule?

Financial markets provide avenues for individuals to buy and sell various financial instruments, such as stocks, bonds, and options. Active trading within these markets involves frequent transactions, often aiming to capitalize on short-term price fluctuations. Participants in these markets operate within regulated environments designed to maintain fairness, transparency, and stability. These regulations help ensure orderly trading and provide a framework for all market activities.

Understanding the Pattern Day Trader Rule

The Pattern Day Trader (PDT) rule is a regulatory designation that applies to certain active traders in the United States. This rule was established by the Financial Industry Regulatory Authority (FINRA) to address specific trading behaviors. Its primary purpose is to safeguard individual investors who utilize margin accounts from taking on excessive risk.

The rule emerged around 2001, after regulators observed that frequent trading with borrowed money could lead to substantial losses for inexperienced traders. The PDT rule ensures traders engaging in high-frequency, leveraged transactions possess sufficient capital to manage potential losses.

This regulation applies to margin accounts, which allow traders to borrow money to increase purchasing power. The rule does not apply to cash accounts, where trades use only available cash. It covers day trading activities across various securities, including stocks and options.

How Pattern Day Trader Status is Determined

An account is designated a Pattern Day Trader if it executes four or more “day trades” within a rolling five-business-day period. This applies to margin accounts. These day trades must represent over six percent of the total trades in the margin account during that timeframe.

A “day trade” is defined as the buying and selling, or selling and buying, of the same security within the same trading day in a margin account. This includes both long positions (buying then selling) and short positions (selling then buying to cover). For instance, if a trader buys 100 shares of a stock in the morning and sells those same 100 shares later that afternoon, it counts as one day trade.

Pattern Day Traders must maintain a minimum equity balance of $25,000 in their margin account. This threshold must be met and sustained for day trading. The $25,000 can be a combination of cash and eligible securities. If the account’s equity falls below this minimum, day trading is not permitted until the balance is restored.

Brokerage firms track trading activity to identify accounts meeting Pattern Day Trader criteria. Once flagged, this designation remains, even if the trader temporarily ceases day trading activities.

Trading Restrictions for Pattern Day Traders

Once an account is designated a Pattern Day Trader, specific restrictions apply. A limitation involves “day trading buying power,” which is the maximum amount a PDT can trade. This buying power is calculated as up to four times the maintenance margin excess from the prior day’s close. Maintenance margin excess is the amount by which the equity in the margin account surpasses the required margin.

If a Pattern Day Trader’s account equity falls below the $25,000 minimum, day trading is restricted. The trader is limited to liquidating existing positions and cannot open new day trades. This restriction remains until the account meets the $25,000 equity requirement.

Exceeding day-trading buying power can lead to a “day trading margin call.” If issued, the Pattern Day Trader has up to five business days to deposit additional funds. During this period, the account’s day-trading buying power may be reduced to two times the maintenance margin excess.

Failure to meet a day trading margin call results in a “90-day restriction” or account freeze. The account is limited to trading on a cash available basis, or liquidating transactions, for 90 days or until the call is satisfied. Funds deposited must remain in the account for at least two business days.

Managing Your Account and the Pattern Day Trader Rule

To manage accounts under the Pattern Day Trader rule, consistently maintain the $25,000 equity minimum in the margin account. This ensures uninterrupted day trading privileges and avoids restrictions.

The PDT rule applies exclusively to margin accounts, which allow leveraged trading. Cash accounts, where trades use only settled funds, are not subject to the PDT rule.

In a cash account, traders avoid PDT classification by fully funding trades and adhering to settlement periods. For most equities, settlement is two business days (T+2). This means funds from a sale are not available for new purchases until two business days later. Repeatedly using unsettled funds can lead to “good faith violations” or “free riding,” resulting in account restrictions like a 90-day freeze.

Some traders use multiple brokerage accounts to manage trade counts. While permissible, each margin account remains independently subject to the PDT rule. This strategy aims to distribute day trades but does not eliminate the rule.