I want to talk to you about the pattern day trader rule, because this rule requires that you have at least $25,000 in your trading account if you are day trading, explains Markus Heitkoetter of Rockwell Trading.
Here’s the tricky part. The tricky part is that you could trigger this rule even if you’re only swing trading, and not day trading, which is why it’s important that you are aware of what the pattern day trader rule is. I will give you examples of what can trigger it, even if it’s accidentally, and I’ll break down what then happens if you trigger it. Most importantly, I want you to be aware of how you can avoid it.
What Is the Pattern Day Trader Rule?
According to FINRA, who set the rule, a pattern day trader is a trader that executes four or more day trades in five trading days. If you execute four or more day trades in five trading days, then you’re being flagged as a pattern day trader. This is not a good thing.
What actually is a day trade? A day trade is a trade that you open and close, during a trading day. As an example, if you buy a stock at the open, at 9:30 Eastern Time, and then sell it before 4:00 pm Eastern Time, you are placing a day trade.
Now, very, very important: this rule only applies to stocks and options. It does not apply to futures, forex, or binary options, only stocks and options.
How To Trigger The Pattern Day Trader Rule
How can you trigger this rule even if you’re swing trading? Well, it happened to me very recently. My head coach, Mark Hodge, and I were trading with our Mastermind members.
I asked Mark to place a trade in my account, but he accidentally placed it in the wrong account.
When something like this happens, I have a rule. “When you make a mistake, liquidate.” I asked Mark to close the position, and when he did, that counted as a day trade. We opened the trade, realized we made a mistake, and closed it right away. This led to me having one strike in this account. And again, if we would get four strikes within five business days, then we would be flagged as pattern day traders.
Now, here’s another scenario. Let’s say that we enter a trade tomorrow, and it hits the profit target or stop loss on the same day. This would be another strike because now we are also entering and exiting during a trading day. As you can see, even if you’re not day trading, it is possible that this could happen a few times. If this happens four times within five trading days, then you’re flagged as a pattern day trader.
What Happens When You Trigger the PDT Rule?
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Well, first of all, if you have more than $25,000 in your account nothing happens. This is because the pattern day trader rule says: if you are a pattern day trader, then you need to have $25,000 in your account. Now if you don’t have $25,000 in your account, then you will be restricted to trade on a cash basis only for 90 days.
What does this mean? Well, as a day trader, you do need a margin account, and when you trigger the pattern day trader rule and cannot put $25,000 in there, this means that now you are restricted to trading with cash only.
Let me give you an example. Let’s say you are trading the Wheel trading strategy, and you put $20,000 in an account. This means if you put it into a margin account, that you get $40,000 in buying power. When you trigger the day trading pattern rule, you no longer get this buying power here, the 2:1 leverage. You are now basically going back to whatever cash you put in there when you trigger this rule.
How to Avoid Triggering the Pattern Day Trader Rule?
Now the question is, how can you avoid this? Well, I want to give you three tips for how to avoid it.
- Number one, have $25,000 in your account. If you have $25,000 in the account, then triggering the rule won’t matter.
- Number two, you want to make sure that you count the number of day trades. Leave the date you placed a day trade on a sticky note and count the number of day trades that you do even if it is accidental, so you can keep track of how many strikes you have.
- Number three, you can avoid it by trading a cash account. If you’re not trading a margin account, you don’t have to worry about it. Then, of course, if you are trading futures, forex, bitcoins (cryptocurrencies), or if you are trading binary options, this is also when the day trading pattern rule does not really matter.
Now you know what the pattern day trader rule is, how you can trigger it even if it is accidentally, what happens when you trigger it, and how you can avoid this.
Learn more about Markus Heitkoetter at Rockwell Trading.