The most important rule concerning day trading of stocks in the United States is called the Pattern Day Trader (PDT) rule. Approved by the SEC, this rule states that you can only perform three day trades within a rolling five-business-day period if you have less than $25,000 in a cash or margin account. However, if you have more than $25,000 in a margin account, there is no legal limit on the number of day trades you may make.
Definition of Day Trading
A day trade is the buying and selling (or shorting and covering) of the same security on the same day.
Penalty for Violating the Rule
You will be flagged as a Pattern Day Trader by the brokerage for that account. Your account will be frozen (no new positions can be added) for 90 days or until you deposit enough cash to get your account value above the $25,000 minimum level, whichever comes sooner. Some brokerages will warn you ahead of time when you are about to be flagged as a PDT, while others will not, so be careful if you trade a lot!
If you violated this rule accidentally and you have no intentions of being a day trader, you have the option of informing your brokerage of the situation and they have the ability to remove the PDT flag from your account.
Why Do They Have This Rule?
The goal of this rule is to protect beginners and those with little cash from participating in risky trading activities that could lead to significant losses in a small amount of time.
Example 1: Safe from PDT Rule
1. Monday: Buy and Sell MSFT
2. Tuesday: Buy and Sell GOOG
3. Wednesday: Buy and Sell F
4. Next Monday: Buy and Sell GM
Result: 3 trades in a 5-day period
Example 2: Violation of PDT Rule
1. Thursday: Buy and Sell MSFT
2. Friday: Buy and Sell GOOG
3. Monday: Buy and Sell F
4. Tuesday: Buy and Sell GM
Result: 4 trades in a 5-day period
Three Days for Settlement
There are several other federal regulations that affect day trading, and the settlement period is one of them. Whenever you buy or sell a position, it takes up to three days for the trade to “settle.” This is similar to a check taking a few days to clear at your bank. In the first three days after a sale, your brokerage may or may not allow you to trade using the money from that sale, since it has not settled yet. This restriction only applies to cash accounts though. The way to get around this problem is to not spend all of your money on one trade. This will make sure you always have some settled cash to trade with. If you have a margin account, your brokerage will lend you the money during the settlement period so that you don’t have to wait before you trade again.