Pattern day traders run financial risks. Many often underestimate them and suffer bigger losses than what they’d expect. The PDT rule is a systematic approach to reducing those risks. This article reviews how PDT trading is regulated in the US stock market and explains how similar risks are addressed on the Olymp Trade platform.
- Day Trading Rules as a Risk Reduction Tool
- Three Qualities of Pattern Day Trading
- Two-Option Choice of the PDT Rule
- Things to Consider About the PDT Rule
- A Better Risk Map with Olymp Trade
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Explanations and definitions of terms.
Day Trading Rules as a Risk Reduction Tool
In the 20th century, rapid expansion and technological advancement made the US stock market the birthplace of trading as we know it today. Common people saw public companies emerge and multi-million dollar fortunes transition from one to another in the stock market. Naturally, they wanted to participate. That sparked Pattern Day trading.
With stock trading made internationally available, the same spark exists today. However, for the majority of traders in the world, most stocks are barely affordable.
A several-hundred-dollar stock is a big investment for them. Therefore, losing it is a similarly big financial risk. Yet, they often ignore it. Driven by a desire to quickly earn fortunes, they dive into trading without a sound risk management strategy. Logically, they often lose.
To prevent those losses at the entry level, the US stock market regulators designed Pattern Day Trading Rules. Essentially, these rules make traders choose one of the two ways to start trading. The first suggests lower-pace trading with smaller funds and, therefore, promotes low-risk skill-building with a well-thought-through approach to trading.
The second allows making a big investment at the very beginning. However, the threshold is so high that it ensures that a trader is either wealthy enough or conscious enough to make such an investment in the face of the financial risks ahead. Below is a detailed examination of how it works.
Three Qualities of Pattern Day Trading
FINRA is a US-based institution, whose objective is largely to make the trading environment safer and more transparent. That is done by regulating brokers and putting certain restrictions on traders’ activity based on specific criteria. One of these restrictions is a Pattern Day Trading rule.
As per FINRA, here are the three qualities that a trader’s activity needs to have to be classified as Pattern Day Trading, or PDT.
- Trading is done with margin.
- More than three trades in five days are closed.
- More than 6% of the total trades in five days are day trades.
Two-Option Choice of the PDT Rule
If the above criteria all apply to a trader’s trading account, they need to make sure that they have a minimum of $25,000 on it at all times. That will allow them to keep trading as often as they want.
Otherwise, if they fall under $25,000, some of their open trades may be held overnight or even a Margin Call may be triggered.
The aim of this regulation comes from the general objective of FINRA. That is traders’ safety. Here is the logic.
Traders need to be fully aware of the risks associated with trading. Therefore, they need to be ready to bear responsibility for it.
For this reason, traders can maintain a total of $25,000 on their account and trade as much as they want.
Otherwise, they need to reduce the pace of their trading to not more than three trades a week if they fall below that level of account funding.
In the first case, if a trader chooses freedom of activity and puts $25,000 on his account, he will most likely be very careful with his transactions. No one wants to lose $25,000. In this case, the PDT rule increases traders’ prudence.
In the second case, if a trader doesn’t want to put $25,000, he needs to reduce the pace of trading because the maximum of three trades a week needs to be observed. By holding down traders’ activity, the PDT rule gives them more time to study the market, helps them to make their decisions better thought through, and serves to better educate them in the long run.
Things to Consider About the PDT Rule
In theory, if a trader wants to make more than three trades a week in total, he can open multiple trading accounts. Formally complying with the PDT rule on each one, he would be able to aggregate the total trading activity on all of them to the desired level.
In the meantime, the reality of trading is that a vast majority of traders quit trading after a few months in the market because they lose money. The PDT rule is intended as an outside restriction tool to make them better adapted to the risks of that reality. However, it is not the only way to address financial risks in trading.
A Better Risk Map with Olymp Trade
For many global traders, while the entry requirements to access the US stock market are restrictively high, the financial risks are similarly high. Also, with most US stock brokers, trading fractional shares is not available. So, if Amazon stock costs $3,000, and you want to trade it, you have to buy it for $3,000 or forget about it. Therefore, there is low accessibility to the market.
With Olymp Trade, you can start trading with $1. Apart from the ease of access to trading, that means you define the value of the investment you are willing to risk. In any case, losing $5 on a single trade is hardly comparable to a loss of $500 with a bad stock trade in the case of the PDT rule.
On top of that, by opening Up or Down trades on stocks in Forex, FTT, or Stocks trading modes on the Olymp Trade platform, you merely make trades on the corresponding stock prices. You don’t become a shareholder and, therefore, don’t face the risks associated with it.
Furthermore, trading fractional shares is available with Stocks mode on the Olymp Trade platform. That means, by opening a trade on Amazon stock, you can specify if you make it with a trade unit fraction equal to 1% of the stock price or simply a $1 worth of it.
From a safety point of view, Olymp Trade’s membership in the Financial Commission is the basis of a transparent trading environment that guarantees traders’ investments in the case of force majeure.
Finally, Olymp Trade provides a comprehensive knowledge base to help you easily learn trading and reduce your financial risks by improving your trading skills.
Therefore, looking at the risks the Pattern Day Trading rules are designed to mitigate, you can enjoy the comfort and efficiency of the trading environment, tools, and instruments available to you on the Olymp Trade platform.To the Olymp Trade Platform
FINRA stands for Financial Industry Regulatory Authority.
A day trade is when you open and close a trade on the same market day.