What is a Pattern Day Trader?
A day trader model is a regulatory designation for traders or investors who trade four or more trades for five business days and in a margin account. The number of daily transactions must represent more than 6% of the total commercial activity of the margin account during this five-day window. The PDT designation is in place to discourage investors from trading excessively. FINRA requires that key date traders have a minimum of $ 25,000 in their brokerage accounts in a combination of cash and certain securities to reduce risk. If the account equity falls below this $ 25,000 threshold, the model day trader can no longer make any day trades until the account is back above this point. This is called the day trader model rule or the PDT rule.
Day Trader Basics
A model day trader is a day trader who buys and sells the same security on the same day in a margin account. Day-traders must also have more than six percent of these transactions in the same margin account for the same period to be considered separate from a standard day trader. These securities may include stock options and short sales, provided they occur on the same day.
Long and short positions, which were held overnight but sold before further purchases of the same security the next day, are exempt from this rule.
The designation is determined by the Financial Industry Regulatory Authority (FINRA) and differs from that of a standard day trader in the number of daily transactions carried out within a period of time. Although both groups have mandatory minimum assets that must be held in their margin accounts, a day pattern trader must hold at least $ 25,000 in their account. This amount does not have to be cash; it can be a combination of cash and eligible securities. If the equity in the account falls below $ 25,000, they will be prohibited from making further transactions until the balance is restored.
If there is a margin call, the trader day pattern will have five working days to respond. Their negotiation will be limited to that of twice the maintenance margin until the call is answered. Failure to resolve this issue after five business days will result in 90 days restricted cash account status, or until the issues are resolved.
These rules are defined as an industry standard, but individual brokerage firms may have more restrictive interpretations. They can also allow their investors to identify themselves as day traders.
Key points to remember
- A model day trader is a trader who executes four or more daily transactions within five working days using the same account.
- Model day traders are required to hold $ 25,000 in their margin accounts. If the account falls below $ 25,000, they will be prohibited from making additional transactions until the balance is restored.
Example of trading profits for pattern days
Take the case of Jessica Dunn, a day trader with $ 30,000 in assets in her margin account. She may be eligible to purchase up to $ 120,000 of shares, compared to the standard $ 60,000 for an average margin account holder. If her stocks gained one percent during the day, as a day pattern trader, she could generate an estimated profit of $ 1,200, which equals a gain of four percent.
Compare that to the estimated standard profit of $ 500, or a 2% gain on a margin account. The potential for a better return on investment can make the practice of day trading attractive to wealthy individuals. However, like most practices that have the potential for high returns, the potential for significant losses may be even greater.