The pattern day trader rule, often referred to as the PDT rule, is one of the most misunderstood stock market terms amongst many beginner traders.
This rule was established in 2001 by the Financial Industry Regulatory Authority (FINRA) and the U.S. Securities and Exchange Commission (SEC).
Today, we are going to focus on the rule, including some of the things you can do to get around it without using an offshore broker.
What is the PDT rule?
The PDT rule requires traders seeking to day trade more than three times in a rolling five-day period to keep a minimum balance of $25,000 in their margin accounts. If an account falls below the $25,000 threshold, the trader is no longer able to execute any day trades until he/she backs up the account above that level.
FINRA defines a pattern day trader as any customer:
- Who uses a margin account; and
- Who executes four or more “day trades” within five business days in a margin account; and
- Whose day trades form more than 6% of his/her total trading activity for the same 5-day period
The PDT rule was designed as a protective measure aimed at preventing traders from trading excessively in the stock market by limiting their trading activity.
This rule assumes that traders with over $25,000 in account equity are familiar with the accepted the risks that day trading entails. Traders found breaking the PDT rule risk having their trading accounts frozen for 90 days.
If you break the rule, you are most likely to get a nasty little message from your brokerage firm, warning and flagging you as a pattern day trader. If you don’t have already a minimum balance of $25,000, you will get a margin call and have a 5-business days term to deposit more funds in your account and lift the balance to $25,000.
Many traders find it annoying when the restrictions kick in. That is why some resort to offshore brokerage firms such as CMEG, TradeZero and SureTrader since those brokers are not subject to SEC and FINRA rules. But trading with unregulated offshore brokers can be extremely risky as some of them are scam companies likely to steal your money.
However, you can get around this rule without using an offshore broker by choosing to trade in a different market altogether.
Well, you see, FINRA does not regulate the futures and options markets in the United States. Yes, that’s right. If you are day trading with futures and options in the US, the agency won’t impose the PDT rule on you.
It is however important to state that you need to have a cash account if you are planning to engage in options trading.
How to get Around the PDT Rule
Below are the top 3 ways to get around the PDT rule:
- Trade in a cash account
- Trade futures
- Trade options
#1 Using a Cash Account to Day Trade
Using a cash account is probably the easiest way to avoiding the PDT rule. The only set back with a cash account is you can only use settled funds.
This means when you buy or sell a stock in a cash account, the money takes 2 days plus the trade (T + 2) date to settle before you can use them again.
So for example, if you sold a stock on Monday those funds wouldn’t settle until Thursday…Monday is the trade date then Tuesday and Wednesday are the two days to settle with Thursday having the funds available.
However, if you have a larger account you can day trade as much as you can until you have used all the funds. For instance, if you have a $20,000 account and you day trade a stock using $5,000, you still have $15,000 to day trade with.
#2 Futures Trading
A futures contract is an agreement that binds a trader to buy or sell assets in the future at a predetermined date and price. Futures contract specify the number of units of an underlying asset that will be sold or bought as well as the time and the price at which that asset will change hands.
The contract usually settles upon its expiration date, at which point the futures holder is obliged to sell or buy the underlying asset at the agreed price.
Speculators and hedgers often use this financial instrument as a way of potentially anticipating future price movements, either for making profits or hedging against risks.
Futures Trading and the PDT Rule
As previously mentioned, the PDT rule does not apply to futures trading. This gives thousands of traders who otherwise could not fulfill the strict requirements set by the FINRA, a chance to access the markets. In other words, even if a futures trader has less than $25,000 in their account, they can still day trade to their heart’s content.
These are the specific rules that apply to futures trading:
- Traders don’t need $25,000 in their accounts in order to day trade
- Day trading margins are determined by the Futures Broker and Clearing FCM
- The exchange determines the overnight margins
#3 Options Trading
An option contract is an agreement between a seller and buyer that gives (but doesn’t require) the seller of the option the right to sell or buyer a particular asset at an agreed upon price at a predetermined date. That date could be as long as a couple of years or short as a day, depending on the type of option contract.
Buying an option that allows you to sell shares at a later date is called a “put option,” while buying an option that allows you buy shares at a later date is called a “call option.”
Selling and buying options takes place on the options market. Options contracts are often used in real estate transactions, securities, and commodities.
Options Trading and the PDT Rule
You can day trade securities such as stocks as much as you want using a cash account, though you have to wait two days for trades to settle if you run out of cash. The good news however is that options trades settle overnight.
Therefore, if you have $10,000 in your account, you can trade two or three options each day as they will settle overnight and the funds will be available for you to trade with again the following day.
However, if you are an active day trader who buys, sells, buys, sells, then you ought to keep a minimum of $25,000 in your account.
If you have less than $25,000, you can still day trade without needing an offshore broke. You just need to exploit the loopholes in the pattern day trader rule. Day trading options in a cash account means that your activity won’t fall under the rule and you won’t be using leverage