Rules of Day Trading – Pattern Day Trader Restrictions – and Pattern Day Trades Examples
Rules of Day Trading
In the stock market, day trading is defined as the buying and selling of the same shares or stocks on the same day. Day trading is also done on other securities such as single-stock futures, bonds and stock options. Day trading is very dangerous and risky to inexperienced traders due to the fact that most of those inexperienced traders are easily carried away by emotions and can open and close many positions without paying attention to ask-bid slippage which can quickly add up into huge loses.
Maximum of Three Day Trades
In a bid to protect the small investors, the NASD and NYSE have instituted regulations to limit the number of day trading to small accounts. Any account with less than $25,000 is a small account and day trading rules apply. The rule is that: small traders can only perform a maximum of three day trades within a rolling five trading-days period. Small traders are all cash and margin accounts with less than $25,000 Net Liquidation Value. This rule is approved by the Securities and Exchange Commission (SEC). The rule is therefore called Pattern Day Trader (PDT) rule and its one of the most important rule concerning day trading of stocks in US security exchanges.
Pattern Day Trader
Pattern Day Trader is therefore a trader who executes more than three day trades within 5 trading days. A Pattern Day Trader is subjected to Pattern Day Trader Restrictions where you are penalized as follows:
1. You account is flagged as pattern day trader by your broker to prevent any morel trades
2. Your account is frozen for 90 days, or you deposit cash to a minimum $25,000, whichever comes sooner.
3. You have the option to alert your broker the rule was accidentally violated and you have no intention of becoming a day trader in which case the flagging will be removed.
When you choose a stockbroker, make sure you pick on the one who has an algorithm in their trading platform of prevent accounts with less than $25,000 from being flagged as day trading accounts. Smart brokerages implements this by prohibiting the opening of the 4th trade within 5 trading days to prevent your account being frozen for 90 days. They should do it for you because if your account is frozen, you stock broker will not be able to make commissions from your trades for the next 90 days. There are still some brokerages out there who unfortunately will not warn you ahead of time when you are about to be flagged as a Pattern Day Trader.
Option Exercise and Assignment Counts as Day Trading Activity
It is important to note that an option exercise or assignment will also counts as a day trading activity. Exception is deliveries of single stock futures, lapse of options, Futures contracts and Futures Options – they are not taken as day trading activity.
Pattern Day Trades Examples
1. You buy on Tuesday 350 shares of IBM and towards the end of the same Tuesday trading day you sell 350 shares of IBM. This is a day trade.
2. You buy on Wednesday 4000 shares of Microsoft and towards the end of the same Wednesday trading day you sell 450 shares of Microsoft. This is a day trade.
3. You buy on Wednesday 400 shares of Dell and in after hours trading of the same Wednesday you sell 250 shares of Dell. This is a day trade.
4. You buy on Thursday 60 shares of QQQQ. On Friday morning you buy another 60 share of QQQQ and towards the end of the same Friday trading you sell 120 shares of QQQQ. This is a day trade.
5. You buy on Friday pre-market 700 shares of CSCO. You sell 500 shares of CSCO on in after hours trading. This is a day trade.
6. You buy 50,000 December call options of QQQQ 40 on Friday. Latter on the same Friday you sell 30,000 December call options of QQQQ 40. This is a day trade
7. You initiate a calendar spread by selling 10,000 September call options of Yahoo 20 and simultaneously buying 10,000 December call options of Yahoo 20 on Friday. Latter on the same Friday you close your positions by buying 10,000 September call options of Yahoo 20 and simultaneously selling 10,000 December call options of Yahoo 20. These are 2 day trades.
What is Not a Day Trade?
1. You buy on Tuesday 100 shares of IBM stock. On Wednesday, you sell 100 shares of IBM. Towards the end of the same Wednesday’s trading, you buy 100 share of IBM stock. This is not a day trade.
2. You buy 300 shares of Google stock on Monday and the following Tuesday you sell 300 shares of Google stock. This is not a day trade.
Minimum $25,000 Net Liquidation
That’s all there is to Rules of Day Trading. Just make sure you do not make more than 3 day trades within 5 consecutive day’s period. Else, make sure you account has $25,000 net liquidation at any one time.
Securities and Exchange Commission (SEC) Cares for You
Securities and Exchange Commission (SEC) has very nice rules. They care not to allow a small trader driving his $25,000 to Zero. But do they care when a trader drive his/her $200,000 to $25,000? They care for a small trader not to short a stock at $40 per share only to come back next month to find the stock trading at $80. But do they care when a small trader buys a stock at $40 per share and the trader watches as the stock drop to $1 per share?
Securities Settlement Period
Other than Pattern Day Trader Restrictions, there are several other federal restrictions that can affect you as a day trader. In the stock market, when you buy or sell a stock, it takes up to three days for that trade to settle. During those three days from the day you sold your stock, you can not make use of that money if you have a cash account. If you have a margin account, this is not a problem because your broker will automatically lend you the money during the settlement period. But this does not mean that a margin account is better than a cash account.
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