How Do You Get Around Pattern Day Trading Rules? - Financhill

How Do You Get Around Pattern Day Trading Rules?

Pattern Day Trader Rule Workaround: When you invest in the stock market, you are taking on risk. That risk may seem reasonable given the potential return you can receive.

It could also appear minimal when you compare the share price today to that at which it traded several years ago. However, these comforts are an illusion. The value of a single stock can plummet drastically in the space of hours.

For some investors, this is expected. They hedge their investments against one another and expect to lose money from time to time.

Other investors can afford to take a massive hit. They have a high net worth or a large portfolio so they can readily recover from a lost investment. Investors who do not fit these parameters could be risking too much – more than what is reasonable. If they choose the wrong stock, they risk permanently damaging their financial futures.

To prevent these investors from losing everything, the financial industry steps in. They create rules the limit what investors can do based on how much money they invest. Pattern day trading is a good example of this. But what if this prevents you jumping in and out, how do you get around pattern day trading rules?

What Is Pattern Day Trading?

Day Trading means that someone opens a position in a stock and closes it in the same day.

According to the Financial Industry Regulatory Authority (FINRA), Pattern Day Trading means that an investor has at least four day trades in a five-day period.

However, this is only a minimum requirement. Your broker may have different standards for what “pattern day trading” means within their organization.

Is Pattern Day Trading Illegal?

Pattern Day Trading is not illegal, but it is regulated.

If you meet the definition of a “pattern day trader,” you will need to meet special requirements.

FINRA sets certain minimum standards for you to meet while your brokerage implements those parameters. Not meeting the standards it sets is prohibited.

What is the Pattern Day Trader Rule?

Per the US Securities and Exchange Commission (SEC), FINRA requires that pattern day traders “must have at least $25,000 in their accounts and can only trade in margin accounts.”

It does not apply to investors who do not leverage their brokerage account. When you use cash, do what you want.

What Pattern Day Trading Restrictions Apply?

Some brokers take a stricter view of what makes a pattern day trader or PDT.

“A broker-dealer may also designate a customer as a ‘pattern day trader’ if it ‘knows or has a reasonable basis to believe’ that a customer will engage in pattern day trading,” explains the SEC. “For example, if a customer’s broker-dealer provided day trading training to such customer before opening the account, the broker-dealer could designate that customer as a ‘pattern day trader.”

How Many Trades Can You Make in a Day?

The pattern day trading rule does not limit how many trades you can make in a single day.

It concerns the number of day-trades you can make within five business days.

You can make up to three day-trades within a single five-day period without being considered a “pattern day trader.”

Pattern Day Trading Examples

To be considered a PDT, you need to make four or more day-trades within five business days. Let’s clarify what that looks like:

Pattern Day Trading Example 1

On Monday, the market starts to explode on strong economic indicator reports. You decide to take advantage of the market inefficiency and double down with a few short-term trades.

You buy stock in four widget companies and sell them off by the close of the market, netting a 20% return on investment.

Congratulations. You are now a pattern day trader.

Pattern Day Trading Example 2

You have been watching XYZ Company for a while. They make great products, but the management is terrible.

On Wednesday, you start hearing rumors of a takeover. The word on the street is that an activist investor is buying a controlling stake in the company.

You buy stock in XYZ the minute you hear the news. Then, you sell off your shares just after the share price peaks.

The next day, there is more news, so you buy and sell again, capturing the stock before trading momentum inflates the prices and off-loading the shares before the market fully corrects.

News on XYZ is quiet Friday and over the weekend, then the stock starts to climb on Monday after the activist investor gives a press conference.

You buy and sell again. Finally, Tuesday hits and the rumors become official. You buy and sell one more time.

You are officially a pattern day trader.

Do Pattern Day Trader Taxes Apply?

If you are a PDT, you may be considered a trader for tax purposes, and this designation has important implications.

Traders have the ability to deduct certain investing expenses from their gross income, including the cost of debt to buy or carry investments and other deductible expenses. They can also make a mark-to-market election. This lets them treat losses as ordinary instead of considering them capital losses.

“Under the mark-to-market rules, dealers and eligible traders are treated as having sold all their securities on the last day of the tax year at their fair market value (FMV), causing gain or loss to be taken into account for the year,” explain the Tax Adviser. “Any gain or loss recognized under this rule is taxed as ordinary income or ordinary loss.”

The difference in taxation can be huge, so don’t overlook this. Talk to your accountant about your options to see if you qualify as a trader, especially if you are a PDT.

How Do You Get Around Pattern Day Trading Rules?

Pattern Day Trading rules are there for your protection, but some investors will want to find a workaround. Whatever your reason for wanting to invest more aggressively, here are some of the pattern day trading rule workarounds:

Fewer Trades

Your first option is to make fewer day-trades.

To be a PDT, you need to make four or more day-trades within five business days. If you only make three during that period, you are golden.

Deal in Cash

Just because you CAN leverage your investment and trade on margin, it doesn’t mean that you SHOULD.

Only you can decide what works best for you, but if you want to make intraday trades and not maintain a minimum account balance, consider using cash.

Try Multiple Accounts

You could also try opening an account at a different brokerage.

This would enable you to make up to three day-trades in a five-day period on each account. It is cumbersome but doable.

Expand your Focus

Day trading is great, but it is not your only option for playing short-lived market inefficiencies.

You can also try swing trading – where you hold a position for a few days or weeks before selling. It will take a different focus – predicting an upswing that lasts an hour is different than betting that momentum around a stock will continue for longer than a day – but it may work for you.

Try Other Markets

Instead of trying to find a loophole, you could expand your portfolio to include different markets.

Investing in forex, futures, options, or commodities is an possibility.

Join the Right Firm

Some brokerages are day trading firms. They tend to let you keep less than $25,000 in your account. They leverage that capital so that you meet the requirement.

Go Foreign

You can also look outside the US. Foreign stock markets have different rules than ones in the United States. Find one that works for you.

Bonus: What to do if you’re Flagged as a Pattern Day Trader on Robinhood.com

Robinhood limits its investors from making more than three day trades in a period of five business days unless you have $25,000 or more in your account.

However, this only applies to Gold or Instant account holders. If you deal only in cash, you have no restrictions.

Robinhood will mark you as a “pattern day trader” as soon as you try to complete your fourth day-trade in a five-day period (again, this refers to business days). Further, you will keep that restriction for 90 days.

What Happens If you are a Pattern Day Trader?

Once you are marked a “pattern day trader,” you will need to make sure your account balance does not fall below $25,000.

The brokerage counts your account balance at the end of the previous trading day, so if you want to be a pattern day trader with Robinhood, you will need to keep at least $25,000 in your account.

However, keep in mind that the funds that count towards your pattern day trading minimum does not include instant deposits.

#1 Stock For The Next 7 Days

When Financhill publishes its #1 stock, listen up. After all, the #1 stock is the cream of the crop, even when markets crash.

Financhill just revealed its top stock for investors right now... so there's no better time to claim your slice of the pie.

See The #1 Stock Now >>

The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.

Top