Many of those getting into the world of day trading will eventually come across the term “pattern day trading.”
Like many other day trading terms, this simply refers to a specific type of trading that has its own characteristics and governing rules.
Some companies have even made a market out of helping people avoid being labeled as a pattern day trader (Robinhood is one such company).
Since you most likely fall into the category of “up and coming day trader,” it would do you some good to add another understood term to your growing pile of day trading lingo.
What Is Pattern Day Trading?
“Pattern Day Trader” (from here on I’ll just call it a PDT) is a classification given to any trader (or his account) that falls under a particular pattern as defined by law. So who gets defined as a PDT? Well, the simplest definition is this: a day trader who trades the same security four or more times per day over a five-day period. Stick to a limit of three trades, and you’ll avoid this designation. But anything more than that, and you’ll be permanently labeled a PDT. It’s all about trade per day ratio.
This is important, so let me explain it once again in a different way; every time you buy and sell a particular stock in a single day, it is considered a day trade transaction. If you repeatedly perform day trade transactions (four times in any five consecutive business days) you are then classified as a “Pattern” day trader.
What Are The Implications Of Pattern Day Trading?
Once your account is tagged as a pattern day trade account there are certain limitations that will be applied based on the equity of the account.
Meaning, if every position in the account were to be closed, the cash value (also known as “liquidation value”) would be the value that would get counted for this purpose.
If the liquidation value of the account is higher than the cash value invested, you are then trading “on margin”. PDTs who trade on margin, have certain requirements, such as they need to maintain a minimum $25,000 cash deposit on their account to cover that margin.
Here is a good explanation of the "Pattern Day Trade Rule" by Sasha Evdakov from Traders Fly :
Why Pattern Day Trade?
Like just about anything else in the stock market, this kind of trading comes with its own set of benefits, and things you should be aware of.
Let’s start with the pros. If you can keep your minimum balance over the required threshold (more on that in a bit), you have certain benefits to this trading style.
First of all, you have increased access to margin, which translates into increased leverage. Meaning, because there is a minimum amount of balance that a pattern trader is required to have in his/her account, the trader has access to this money as an amount that can be borrowed on.
Now, you may have to keep that minimum amount put, but that doesn’t mean you can’t make it work for you.
In this business, this is called “day trading buying power,” and can sometimes be valued at four times the cash value.
So if you’ve got $30,000 in cash, you could be looking at being able to trade up to $120,000 in stock. More value means more leverage, which means more buying power, which means more potential profits.
What Should You Know?
Among the top things to know regarding pattern day trading, one of the most important is what I mentioned above -- you need to have a minimum balance in your account. The amount? $25,000. While you can leverage this amount, you do need to keep it at this minimum level. Should you fall below this amount, you’ll be denied access to markets; obviously a no-go in the trading world.
Secondly, if you’ll remember above, pattern day trading is defined by the amount of trades completed. That means that you need to keep track of how many trades you’re doing during that rolling five-business-day period. Doing more than the minimum amount of trades means you need to have that minimum amount of equity. Losing track of trades and slipping below $25,000 could mean missing out on potential trades, and profit.
And one last caveat: remember that day trading buying power that could be up to four times the value of the equity? Well, the operative word here is “day,” and it’s an important thing to keep in mind.
That value is only applied to purchases that occur and are closed within that same business day. If you keep the trade open past the end of the market day, it’s no longer a day trade, and is subject to certain regulations.
Which means that if you don’t have at least half of the leverage amount, your broker may be forced to liquidate holdings in the account in order to comply with federal rules. Needless to say, this is something you want to avoid.
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Here are our recommended day trading platforms.
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As you can see, being designated a PDT is something that’s probably going to happen if you’re looking to be a successful day trader; making four or more trades just comes with the territory.
However, if you can keep a careful eye on both the amount of trades you’re doing in a five-day period, as well as make sure that your equity amount is above the minimum amount of $25,000, you’ll have access to some great leverage options.
And now that you’re armed with this information, go forth and trade!