Overview of Pattern Day Trader

First, let’s establish the definition of a pattern day trader.

A pattern day trader is when you open four or more round-trip trades in five business days.  So, if you open one trade each day Monday through Thursday, by Friday morning you have now been tagged as a pattern day trader.

Brokerage Firm Notification

Once you have decided to be a rebel and place the four or more trades, you will get a notification from your brokerage firm.

This notification will make you feel like you have just made America’s Most Wanted list.

You will receive an email, text, and notification within your platform. This notification will look something like this:

How do I know? This notification was sent to me from Interactive Brokers!

Why Did I Receive the Notification?

I was trading the Nikkei for over a year trying to crack that market.

Unlike America, Japan does not have a restrictive 25k margin requirement, so this allowed me to trade the market with a small account.

At any rate, IB had some tech update which flagged my account as a pattern day trader because my home country was not Japan. So, just like that my global equities trading dream was crushed.

I’m going to get into why the pattern day trader rule is completely bogus in my eyes.

Pattern Day Trader Restrictions

Going back to the photo, look at the restrictions that were placed on me:

• The account must have a balance of $25,ooo.
• I have to wait 95 days from the time my account has triggered the PDT trigger to trade. This is the wake-up call that if I don’t stop my account will be locked and I cannot place trades.
• I can ask for a review of my account status, and Interactive Broker will do a manual review, and if I am lucky, they will lift the lock. But this comes with the catch of I can only request this review once every six months.

Now please do not take this post as a bash of Interactive Brokers. They are at the mercy of the Financial Industry Regulatory Authority (FINRA) that are enforcing FINRA Rule 4210, which governs margin and how much money you need to have in your account.

Why Do We Even Have the Pattern Day Trader Designation?

After the internet bubble of the late 90s, it was believed that speculators were the reason for the crash. The government also felt that the everyday retail investors were all trying to get rich, and lost money that they otherwise would not have if they hadn’t had these dreams of financial independence.

The government felt that they were protecting the retail traders by creating margin requirements.

How did the Government come up with 25k?

You guessed it; the government talked to the brokerage firms. Now, you would think the question would be is there any empirical data that shows a person with a certain asset level is more likely to succeed at day trading?

Wrong.

It was never about protecting us; it was about protecting the banks. The banks gave the feedback that $25,000 was the floor because this is the level banks felt was required to give them the cushion they need to manage the risks associated with margin accounts.

Don’t believe me, check out FINRA’s website which provides an even more detailed answer.

This is where I just lose it.

There were dozens of other options the Government could have taken to address this issue. For example, don’t allow four times margin. Place even greater cash requirements for shorting or trading highly volatile stocks.

None of these worked, that would have protected Americans wallets while still allowing us to achieve our financial dreams. What they decided to do was increase the size of the cash required by retail traders.

Why Would Brokerage Firms Want Us to Have 25k

For me, it’s as simple as this – greed.

Most retail traders end up washing out. I’m not going to labor over this negative topic, but it’s just the fact. Again, I believe this has little to do with people’s actual ability to pick up trading, but more to do with they don’t give themselves the time they need to master their craft.

Hell, it took me close to 5 years of grinding it out before I was able to turn a consistent profit weekly.

So, the banks and brokerage firms know that becoming a professional trader is not easy.

The 25k just allows you to place more unnecessary trades with little to no knowledge of what you are doing so the brokers can reap the trading commissions. Having a larger account value keeps you in the game longer, which again keeps their commission stream flowing.

Studies Show a Grim Picture

France conducted a study of retail trader performance and published the data. For some reason, we are unable to do the same thing in America.

The study showed that over 90% of traders lose money.

Of the 10% that made money, on average their take was 2,190 Euros a year.

Sorry, but that’s not enough money to live on. So again, why are we asking people to fund accounts with $25,000 if they are not likely to turn a profit?

A Larger Starting Account Balance Does Not Equal Success

Let me be the first to tell you that an investor with $10,000 dollars and an investor with $500,000 have the same level of risks when it comes to losing money.

A person may have just had a more lucrative career or received a large inheritance. It doesn’t mean that person will somehow be a better investor or able to manage the risk more effectively. This logic is just completely biased and quite frankly un-American.

I have talked to traders that have lost a million dollars, and that was there only million dollars. So, again it’s all relative.

People Find Ways to Fund the 25k

The real problem is that people will scrape and claw to get up to the $25,000 level using credit cards and dipping into an emergency fund. It can get really bad once people go to one of these off-shore brokerage firms with ridiculous fees in hopes of building their account up to the 25k requirement.

4x Margin is the Real Issue

Instead of figuring out how to trade profitably, trades want to make money and make money fast. They then fall into the trap of using some or all of their four times buying power to start trading.

Well, what do you think happens when a trader with little experience and $100,000 starts trading with $400,000 using margin? You guessed it; they blow up their account.

This Reduces Access to the World of Active Trading

Why should I be able to day trade and not one of my other fellow citizens? Just because I have more money in an account? The whole idea is ridiculous.

The markets did just fine before this rule was in place and it does not prevent selloffs; the mortgage crisis proves my point.

By reducing access to the markets, we reduce liquidity which is the lifeblood of our economy.

How Do You Get Around The Requirement

Open More Than One Account

You can open accounts with different firms. Since each account can place three trades in a five business day cycle, if you have four accounts, you can place nine trades in a week.

Unless you are scalping, this is all you need to get started. This way you can fund each account with the smallest amount but still get the experience of placing real trades.

This also prevents you from losing major funds. With some brokerage firms requiring only $2,000 dollars to get started, you could be up and running with four to six thousand dollars.

I don’t want to minimize how difficult it is to come up with that kind of money, but it’s much better than having to produce $30k.

Remember, 25k just allows you to place the trades, if you go one dollar below the threshold you will start to get the notices like the one above.

Some will say you can fund the account but not use the money. I have two issues with that point: (1) who wants to just park money in an account and not make a solid return on it and (2) at some point your discipline may get the best of you, and you start to dip into those funds.

In Summary

First thing is you need to accept learning to trade is hard. Anyone that tells you otherwise is setting you up for unrealistic expectations.

Learning strategies and patterns isn’t even the half of it. Trading is mostly mental, requires tremendous discipline and money management skills.

These are things as a discretionary trader you have to learn over time by placing trades.

How Can Tradingsim Help?

If you are impacted by this designation, you can practice trading in Tradingsim 24/7 and learn how to find the strategy and money management techniques that work best for you.

Again, the winners in this game all have had enough time to learn and master the craft. Just having $25,000 will not guarantee your success.

Photo Credit

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