Pattern day trading rules have been getting tighter since February of 2001 when the SEC approved a set of rules and regulations for “pattern day traders”. This was later amended in 2013. These rules had to be followed by stock brokers and exchanges. To the average person using cryptocurrency, this may not mean much. But pattern day trading is a way of day trading that is restricted and requires you to follow specific guidelines
Retail investors are subject to restrictions due to the pattern day trading rule. The law forbids traders from making a predetermined number of trades in a short period of time. By being aware of the restriction, professional traders can avoid making legally required margin calls.
By the end of this article, we will have clarified what pattern day trading is, how to follow the guidelines, and which situations are subject to restrictions.
- What Does Pattern Day Trading Mean?
- What Happens If You Pattern Day Trade?
- Can you get flagged as a Pattern day trader?
- Examples Of Pattern Day Trading
- Pattern Day Trading Rules
- Is there a pattern day trading rule for the crypto market?
- How to Follow Pattern Day Trading Rules
- In the UK and Canada, is there a pattern day trading rule?
What Does Pattern Day Trading Mean?
The US Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) introduced the pattern day trading rule in 2001. The rule’s objective is to safeguard day traders from the dangers of leveraged retail trading accounts. When crypto day trading on margin, successful day traders must show they have the financial means to cover losses.
What Happens If You Pattern Day Trade?
Except for the freezing of a margin account, until additional funds are deposited, a pattern day trading violation is not subject to any fines. The law does not cover cash accounts. Since the broker imposes the restriction, the punishment may differ. The flag eventually fades and is not always present. Typically, it lasts for 90 days, but if a broker is understanding, the time frame may be shorter.
Since the ban is intended to protect retailer traders, it does not apply to institutional stock brokers. Being a pattern day trader is not prohibited, but those who are suspected of using the tactic must demonstrate their ability to bear the risks involved. When filing your taxes, you might discover that you are a pattern day trader with enough capital to be eligible for Trader Tax Status (TTS).
So, if you happen to Pattern Day Trade, you will be prompted to add more capital to your account if the pattern day trading recognition software determines you have reached the threshold. After completing this, you can resume regular cryptocurrency trading. If not, you will be limited to only closing trades.
Can you get flagged as a Pattern day trader?
If you execute 4 or even more day trades within 5 trading business days, you will be considered a pattern day trader, given that the number of day trades signifies more than 6% of your overall trades within your margin brokerage account during that same 5 trading day duration.
Unless you have at least $25,000 in portfolio value (notwithstanding any cryptocurrency positions) in your margin brokerage account as of the end of the previous day, you are generally limited to no more than three-day trades in a five-day period.
This may sound complicated, but it simply means that after your 4th-day trade in any five-day period, you will be flagged as a pattern day trader, and you will need to have a portfolio value (apart from any crypto positions) bigger than $25,000 at the end of each trading day to be able to resume day trading the next day.
Although the value of your portfolio may occasionally rise above $25,000 during a trading day, we only take that day’s closing balance into consideration. Keep in mind that only the cash, options, and stocks in your brokerage account are included in this value, which excludes any cryptocurrency positions.
All brokerages must uphold the $25,000 portfolio value requirement because finra rules established it. On the FINRA website, you can find more information about day trading regulations if you’d like.
Examples Of Pattern Day Trading
When examples are used to explain the pattern day trading rule, it becomes clear. Let’s say John put $1,000 into a margin account. It would be considered a single day trade if he shorted Apple shares on Monday and closed the position during regular margin trading hours on the same day.
Imagine that he then decides to go long position on Tuesday and closes the position soon after realizing a profit. John would be issued a warning for making four-day trades in a five-day span if he were to repeat this pattern on Wednesday and Thursday.
Pattern Day Trading Rules
When four or more day trades are closed in a five-day period and their combined value exceeds 6% of the deposit capital, the trader is said to be a pattern day trader. If the trading account holder has reached this limit, the broker will enforce a day trade margin call, requiring them to make a larger deposit.
According to the rules, a trader should be limited to closing trades during this time. The trader may carry on if they satisfy the margin call. A pattern day trader must have $25,000 in equity on their platform as a minimum.
Not only does the pattern day trading rule apply to forex, but also to all other securities. They include futures, options, penny stocks, shares, bonds, CFDs, ETFs, and cryptocurrencies such as Bitcoin.
Is There a Pattern Day Trading Rule for Crypto?
When you buy and sell the same security (such as stocks or ETFs) on the same trading day, it is referred to as a day trade. Since there are no restrictions on day trading cryptocurrencies, the Pattern Day Trader rule as defined by FINRA does not apply to cryptocurrency trades.
How to Follow Pattern Day Trading Rules
It is not advisable to look for loopholes because the pattern day trading rule was created to prevent retail traders from taking on risks they cannot afford. Here are some suggestions on how to get around the pattern day trading rule for those who are unable to meet the $25000 margin call.
- Hold positions overnight: Day traders are the only ones who must abide by the PDT rule. As a result, holding a position overnight would not count toward your allotted four trades.
- Premarket vs. after-hours: If a trade is closed on the same day after business hours, it is not considered a day trade. It does count as a day trade, though, if you open a trade premarket and close it the same working day.
- Trade outside of the US: The SEC and FINRA have a rule against pattern day trading. As a result, it only applies to US traders who use brokers who execute trades within the US. Top choices include Revolut, eToro, Coinbase, Questrade, and Robinhood. It includes all tradable assets, including commodities like gold, stocks, bonds, and cryptocurrencies.
- Open several broker accounts: Brokers shouldn’t communicate with one another about how many trades they have made. Data protection laws would most likely be broken by this. Therefore, opening a second account with a different broker without being warned will allow you to execute twice as many day trades. The minimum deposits and doubled commission are drawbacks, though.
- Cash Account: Use a cash account because margin accounts are the only ones where pattern day trading is legal. You can completely avoid the rule if you are trading without margin (using a cash account).
- Take into account the implications for broker training: A broker may add a pattern day trading disclaimer to an account if they have a great way to believe this is one of your strategies. One typical trading strategy is to inform the broker of any day trading training credentials.
- Sufficient Captial: Having enough real money in your account to demonstrate that you can afford the risk is required for pattern day trading to be legal. Keep your account sufficiently funded if you have $25,000 to trade and don’t worry about the rule or how to turn it off.
In the UK and Canada, could there be a pattern day trading rule?
Only traders based in the USA are subject to the pattern day trading rule. It does not apply to people doing business in the UK, Europe, India, Australia, or the majority of other countries. If the broker clears trades via the United States securities exchange, it might also apply to traders in Canada.
Wealthsimple, Vanguard, Chase, Interactive Brokers, Stake, WeBull, Degiro, Schwab, and Fidelity are a few US brokers that use pattern day trading rules.
Is Pattern Day Trading Bad?
The practice of pattern day trading is not inherently bad and is legal. Day trading on margin, however, is a dangerous activity. The goal of the rule is to limit losses for crypto day traders out there that cannot afford the high risk. This is accomplished by freezing a retail account until they can demonstrate that they have enough money to cover any possible losses.
Can I Pattern Day Trade?
You are free to day trade crypto as much as you want if you’re trading outside of the US or have the money to guarantee a minimum balance of $25,000 in your margin account at any given time. You might not be allowed to day trade if you don’t meet these requirements.
Conclusion Regarding Pattern Day Trading Rules
To shield US traders from potential losses when trading on margin, the pattern day trading rule was created. It applies to stocks, options, futures, and forex. In actuality, it covers all securities. Fortunately, there are ways to prevent getting a flag on your account, including adding more money to your deposit, limiting the number of trades you make, and closing positions overnight.
However, if you don’t meet the requirements for that, you can always try to do the normal day trading which won’t necessarily require you a $25K account.
You are free to day trade as much as you want if you’re trading outside of the US or have the money to guarantee a minimum of $25,000 in your margin account at any given time. You might not be allowed to day trade if you don’t meet these requirements.
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