A pattern day trader is a regulatory designation for an investor using a United States brokerage margin account who executes four or more day trades within five business days.
Regulatory framework and requirements
The pattern day trader designation is a rule established by the United States Securities and Exchange Commission and the Financial Industry Regulatory Authority. It applies specifically to traders using margin accounts at United States brokerages. Elephants trading through non-US brokers or using standard cash accounts are not subject to this specific regulation. A day trade occurs when a trader buys and sells, or short sells and covers, the same security on the same trading day.
When an account is flagged with the pattern day trader designation, the trader must maintain a minimum account equity of $25,000. This equity can be a combination of cash and eligible securities. The $25,000 minimum must be in the account before any day trading activities occur on a given day. If the account equity falls below $25,000, the broker will issue a day trading margin call.
If a trader fails to meet the day trading margin call, the broker restricts the account. The account is limited to closing transactions only for 90 days, or until the trader deposits sufficient funds to restore the $25,000 minimum balance. Brokers track the number of day trades on a rolling five-business-day basis.
Accounts that meet the $25,000 minimum equity requirement receive increased day trading buying power. A pattern day trader is permitted to trade up to four times the maintenance margin excess held in the account as of the close of the previous business day. This provides higher leverage than a standard margin account.
Example
An elephant trader named Barnaby opens a margin account with a United States broker and funds it with $18,000. On Monday morning, Barnaby buys 100 shares of an agricultural stock and sells them that afternoon to capture a short-term price movement. On Tuesday, Barnaby executes two more day trades on the same stock. On Wednesday, Barnaby executes a fourth day trade.
Because Barnaby executed four day trades within five business days, the broker flags his account as a pattern day trader. Barnaby only has $18,000 in his account, which is below the $25,000 minimum requirement. The broker issues a day trading margin call and restricts Barnaby from making any new day trades. Barnaby must deposit at least $7,000 into the account to resume day trading.