Pattern day trader_pattern-day_trader_rules_un_americanDocument Transcript
Pattern Day Trader – Pattern Day Trader Rules Un-American Pattern Day Trader Rule While the pattern day trader (PDT) rules were created with the best of intentions, I find the regulations simply absurd! I honestly believe the regulations do more harm than good to the markets by keeping traders out of the market and limiting liquidity.The pattern day trader rules were adopted in 2001 to address day trading and margin accounts.The US Securities and Exchange Commission (SEC) rules took effect February 27, 2001 andwere based on changes proposed by the New York Stock Exchange (NYSE), the NationalAssociation of Securities Dealers (NASD), and the Financial Industry Regulation Authority(FINRA). The changes increased margin requirements for day traders and defined a new term,“pattern day trader.” The rules were an amendment to existing NYSE Rule 431 which had failedto establish margin requirements for day traders.Why Was It Changed?The rule was changed because the previous rules were thought to be too loose. Risky traders, atthe height of the tech bubble, were day trading without the proper financial backing to cover theirhigh-risk, short-term trades. Day traders were using “cross guarantees” to cover marginrequirements in their accounts. These cross guarantees resulted in massive, and often unmet,margin calls in losing accounts. The rule was intended to keep real money in margin accounts forindividuals who engage in what is deemed risky, pattern day trading.Most day trading accounts end the day with no open positions. Since most margin requirementsare based on the value of your open positions at the end of the day, the old rules failed to coverrisk generated by intraday trading. The pattern day trader rule is meant to provide a cushion forthe risk created by intraday trading. Prior to the rule, it was possible for accounts to generatehuge losses with no collateral to support the trades. Many traders and capital firms were wipedout as a result of the tech bubble bursting.What Is A Pattern Day Trader?The definition of pattern day trader on the FINRA website is any “margin customer that daytrades four or more times in five business days, provided the number of day trades is more thansix percent of the customer’s total trading activity for that same five-day period.” According to therule, traders are required to keep a minimum of $25,000 in their accounts and will be deniedaccess to the markets should the balance falls below that level. There are also restrictions on thedollar amount that you can trade each day. If you go over the limit, you will get a margin call that
must be met within three to five days. Further, any deposits that you make to cover a margin callhave to stay in the account for at least two days.Can I Day Trade in My Cash Account?Day trading is usually only allowed in margin accounts because the practice of day trading couldviolate free-ride trading rules. Stock transactions take three days for settlement. Buying andselling stocks on the same day in a cash account could violate the rule if you are trading withfunds that have not yet settled from a former purchase or sale. In other words, the danger lies inusing the value of an unsettled trade to engage in another trade. This type of activity will get youraccount suspended for up to ninety days or more. Margin account requirements are meant toensure that your account will have the necessary equity to cover your transactions withoutbreaking the free-ride rule.What if I Break the Pattern Day Trader Rule?The average investor is allowed three day trades in a five-day rolling period. If you make morethan three day trades in that five-day period, then your account will be restricted to only closingtrades. If you violate the pattern day trader rule the first time, you will likely just get a warningfrom your broker although I have heard of some enforcing it on the first violation. If you violatethe pattern day trader rule a second time your account can then be suspended from trading forninety days. It is understandable that the SEC would want to protect the market from riskytraders, but the rule does little to actually prevent it. It merely entices would-be day traders toover extend themselves in order to get into the market and then allows them to borrow up to fourtimes the account value with certain brokerage firms that offer leverage.Wouldn’t it be better if small traders were allowed to trade on a cash-only basis as their accountspermitted? The pattern day trader rule states that an account holder with a value of over $25,000is deemed “sophisticated.” Therefore, if someone has $24,999 in an account, then they are notsophisticated. So the rule implies that a one dollar difference in account size earns yousophistication. How ridiculous! The SEC intended to help the markets and investors betterprotect themselves. Last time I checked, this is the United States of America. I find it odd that thegovernment is worried about people losing money in the US Stock Market but, I can go to theany casino and lose my life savings on one roll of the dice. The pattern day trader rules justinterfere with free market action.Do Pattern Day Trader Rules Cover All Types of Trades?Oddly, the PDT rule only applies to stocks and options. Other tradeable securities are excluded.You can trade as many futures contracts or Forex pairs as you would like. It is also possible toget around the rule by overnight or day-to-day trading, instead of actual intraday trading. A daytrade, by definition, is a trade that is opened and closed on the same day. A trade opened in pre-market and closed during normal trading hours, or even after the closing bell, is considered a daytrade. If you buy stocks or options three times in one day and close them all on that same day, it
is considered three day trades. However, a trade that is opened at the close one day, and closedat open on the next day, does not count as a day trade.Why Are Pattern Day Trader Rules Bogus?The PDT rule is bogus for a number of reasons. The rule targets small investors and keeps them out of the market. If your account is large enough that four day trades is less than six percent of your total trading volume, then you probably have significantly more than $25,000 in your account. The beginner trader starting out, speculating in the markets, does not have $25,000 in their trade account. Once you have been pegged as a pattern day trader by your broker, it is likely that they will maintain that rating. It creates a reasonable belief that you will engage in high-risk day trading until you get above $25,000. After you violate the rule once, the penalties will become more strict. The rule interferes with normal market functions. Speculating and shorting the markets are natural and beneficial aspects of market functions. They each add liquidity and help to balance supply and demand. By requiring margin account minimums, the SEC is keeping potential market participants out of the market and limiting liquidity. The worst part of this rule is the restriction to potential short sellers. Options are not marginable. You cannot buy an option on margin, so why do you have to maintain margin limits in order to trade them. It is ridiculous. Unfortunately, all US based brokers are required to enforce the pattern day trader rules. Why $25,000? I can understand having a margin requirement, but why such an arbitrary number? It only takes $2,000 to open most margin accounts, so why can’t day traders use the same amount? It would much safer for a beginner to test the water with one month’s rather than most of one year’s salary. It puts limits on speculative trading that isn’t in the spirit of day trading. As a short-term trader, I tend to make a lot of trades. For the most part, they are open for a couple of hours, days, and sometimes, up to a few weeks. I always trade in cash, but if I have a run of being really right (or wrong) in the market, then I could easily have three or more trades close in the same day. That’s sensible risk management. It certainly doesn’t make me a risky or pattern day trader. Managing risk is one of the foundations of trading. The pattern day trader rule hinders the ability of traders with account sizes under $25,000 to limit risk through quick trades.Pattern Day Trader ConclusionUnfortunately, the pattern day trader rules have been in effect since 2001. It doesn’t look likechange is coming any time soon. Over the last few years, I have worked with quite a few traders
that begin trading with accounts that are significantly smaller than $25,000. I have been able tocreate five ways to get traders around the pattern day trader rule.---------------------------------------------------------------------------------------------------------------------------------To learn more, download my Free - 5 Step Formula To More Profitable Trades http://www.OptionSIZZLE.comJoshua Belanger is the founder of OptionSIZZLE.com where he provides free and premium option tradinginformation and resources.