The biggest barrier to trading, the annoyingly confusing PDT rule. What is it? How does it effect your trading? Why do different brokers treat it differently?
I want to clear up the mass confusion that comes to the Pattern Day Trade rule or PDT. It’s well known that this rule kept me from day trading for many years. In its simplest form, anyone who wants to trade stocks freely and unlimitedly needs over $25k in their trading account in order to do so. I would get to that part in the book I was reading about how to trade stocks and just close it. Feeling like my dreams of becoming a day trader was just that, a dream. I never really looked further in to it till years later and found that was one of my biggest mistakes.
Since I’ve been trading, I’ve been under the 25k minimum requirements with Etrade and Speedtrader. Surprisingly they had different ways of dealing with the PDT rule. That’s lead me to believe that other brokers may treat it differently also.
If you make more than 4 trades (a buy and a sell are both counted as a trade) in a five business day period (provided the number of day trades are more than six percent of the total trading activity for that same five-day period), your account is automatically labeled as a PDT.
Once labeled a pattern day trader by your broker, you will need over 25k to make unlimited trades. For many, being labeled a PDT and having less than 25k in your account means you need to really strategize your trading. It also may depend on your broker. Here’s an example of what I experienced with Etrade and SpeedTrader with less than 25k.
Etrade: As a PDT they allowed me to buy and sell a stock the same day but I was limited to trading my account value and was not given any margin. So for example, if I had 10k, I could buy and sell 10k worth of stock on a given day, but once I did that, I was out of buying power. I had to wait 4 business days for the money to “settle” and allowed to trade with again. In order to have money available to trade everyday, I would have to limit only trading 1/4 of my account value everyday.
SpeedTrader: I was surprised when I switched to SpeedTrader and found they have different rules when it comes to the PDT. The basics still apply however they would not let me sell any security the day I bought it. Also they still offered margin so I had increased buying power. So I was able to have more buying power at SpeedTrader but I could not sell the day I bought. With SpeedTrader, any trade I took no matter how much money I was up or down, I had to hold till the next day. Basically a forced swing trade. I was happy to have the increased buying power but not being able to sell was really frustrating sometimes. SpeedTrader does allow traders to remove the PDT restriction one time, and will allow them to sell the day they buy as long as they keep their trading activity in check.
Deciding between the two, I was torn because I really liked having the freedom to sell the same day, however the increased buying power with SpeedTrader gave me a lot more leverage to increase potential gains(also losses).
How do you avoid the PDT rule and trade freely under 25k?
The only way to avoid it is by joining an offshore broker like SureTrader or a Proprietary trading firm.
SureTrader is an offshore broker that operates almost identically to Speedtrader but the money is held offshore. This allows non-restricted trading as if you had over 25k in a US broker account. I have a full write up of my experiences with SureTrader here. Many traders utilize this option including myself. My only complaint is the fees can be a little higher than other brokers but to have the freedom to buy and sell unlimitedly and also have 6:1 buying power is no brainer for me.
A Proprietary Trading Firm or prop firm offers their own capital to traders by way of a membership fee. Traders pay a fee set by the prop firm and in return they get an allotted amount of money to trade with. It works similar to most brokers but the prop firm sets restrictions to position size, auto stop loss and may take a share of your profits. I think prop firms are good way for beginners to learn how to trade and in most cases you can get your membership fee back. Make sure you read all the fine print as there are many prop firms out there with different requirements and rules.
I hope this helps everyone understand the rule and how to trade around it if need be. The easiest way to avoid it is by having over 25k, but for many that isn’t easily available. With the exception to slightly higher fee’s, SureTrader is the easiest way around the PDT rule so you can trade as much as you want with out restrictions.