Day traders, just like other investors, come in many shapes and sizes. As you begin to learn more about the world of stocks and shares, you’ll discover that there are various ways that you can get involved, depending on your individual capacity for risk and the strategies you want to use build your wealth.
The term pattern day trader is one of the most commonly misunderstood in the stock environment, so we thought it was about time we helped you to understand what it means. A PDT is essentially a regulatory designation used by the investor landscape, but let’s dive into the concept a little further.
Defining the Pattern Trader
All investors use trends and indications in the market to determine when they should buy and sell the stocks and shares that they collect for their portfolio. To be defined as a PDT, you need to be an individual that executes over four trades during a period of five business days. At the same time, those buy/sell strategies need to take place from a margin account.
There are plenty of rules and guidelines around the concept of investing. For instance, the Financial Industry Regulation authority indicates that the number of buys and sells that takes place from a pattern day trader will need to make up over 6% of the total trade activity in the margin from the five-day window of investing.
This designation is in place to ensure that people don’t feel encouraged to spend excessively. The FINRA also requires that individuals maintain a minimum of at least $25,000 in their brokerage accounts. This amount can be made up of a combination of certain securities and cash to reduce risk.
If you’re running a PDT account and the value of your account drops beneath the $25,000 threshold, then you’ll no longer be able to complete any day trades until that account is back up above the correct level. This is the PDT rule.
Why Does the Definition Matter?
So, why does it matter if you can officially be classified as a PDT or not? Well, if you are this kind of buyer, then you will have a margin of around 25% in your account, which means that you can borrow up to 75% of the cost for the securities and investments that you want to sell and buy. This is a huge advantage that you can have over most customers, who are only allowed to borrow about 50% of the cost of their purchases.
The reason that they allow these people more leeway is that they usually close their positions overnight. This means that there’s a lot less risk to the firm lending the trader the money to have the loan ongoing and outstanding. However, if you are a PDT, you’re also under a lot more pressure to perform.
PDTs need to sign an agreement that says you understand the risks associated with borrowing money, including the fact that you might need to repay more than you have in your brokerage account. Additionally, your broker may also have the potential to sell securities from underneath you to make sure you pay what you owe.