What Is the Pattern Day Trader (PDT) Rule?
What Is a Pattern Day Trader?
The rule defines a pattern day trader as someone who executes four or more day trades in a margin trading account within a five-business-day period.
In a margin trading account, a pattern day trader is subject to several rules, including the requirement to maintain a minimum equity balance of $25,000 at all times. If the account balance falls below this amount, the trader may be restricted from making additional trades until the balance is restored.
Does the Pattern Day Trader (PDT) Rule Apply to Cash Accounts?
In a cash trading account, the PDT Rule does not apply, and traders can buy and sell securities as often as they like using only the funds available in their account. However, a three-day settlement rule applies, which means that funds from the sale of a security cannot be used to purchase another security until three business days have passed.
Why Does the Pattern Day Trader (PDT) Rule Exist?
The SEC implemented the PDT Rule in 2001 as a way to regulate day trading and reduce the potential for fraud and market manipulation. It also protects inexperienced and unsophisticated traders from the risks associated with day trading. Day trading involves buying and selling securities within a single trading day, and it can be a highly risky and volatile activity.
The PDT Rule also requires brokers to monitor the trading activity of their customers and enforce the rule if necessary. This helps ensure that traders are aware of the risks associated with day trading and are taking steps to manage those risks effectively.
What Happens if You Break the Pattern Day Trader (PDT) Rule?
If you break the PDT Rule, your brokerage firm may impose restrictions on your account or take other disciplinary action. Here are some possible consequences of violating the rule:
- Account restriction: If you are classified as a pattern day trader and your account falls below the minimum equity requirement of $25,000, your brokerage firm may place a restriction on your account. This restriction may limit your ability to make trades for a certain period of time until your account balance is restored to the required minimum.
- Margin call: If your account balance falls below the margin requirement, your brokerage firm may issue a margin call, requiring you to deposit additional funds to meet the minimum requirement. If you fail to meet the margin call, your brokerage firm may liquidate your positions to cover the shortfall.
- Account suspension: In some cases, a brokerage firm may suspend your account if you repeatedly violate the PDT Rule or other trading rules. The suspension may last for a certain period of time, or the firm may terminate your account altogether.
- Regulatory action: Violating the PDT Rule may also result in regulatory action by the U.S. Securities and Exchange Commission (SEC) or the Financial Industry Regulatory Authority (FINRA). This may result in fines, penalties, or other disciplinary action.
It’s important to understand and follow the PDT Rule if you are a day trader, to avoid these consequences and to protect yourself from the risks associated with frequent day trading.
The Bottom Line
While the PDT Rule may be seen as a barrier to some traders who want to engage in frequent day trading, it ultimately exists to protect traders from the potential for significant losses and to promote market stability and integrity. By requiring traders to maintain a certain level of equity in their account, the rule helps ensure that they have the financial resources to handle the risks associated with day trading.