4 Best Way to Avoid the Pattern Day Trading Rule (PDT)

What is the Pattern Day Trading Rule

The pattern day trading (PDT) rule is designed by US financial market officials to help protect inexperienced traders from what they consider a risky version of trading. Whether traders agree with the rule or not, they need to either follow it or find a way around it.

The Pattern Day Trading rule is a regulation enforced by the US Securities and Exchange Commission (SEC) that applies to US traders who buy and sell a stock on the same trading day four or more times within a period of five trading days.

If a person is making four or more day trades in a five-day period, the rule requires that trader to maintain a minimum account balance of $25,000 in their margin account. The rule was implemented in 2001, following the dot-com bubble burst; inexperienced traders flooded the market and often incurred devastating losses in the process.

The SEC considers day trading to be a high-risk activity that requires significant market knowledge and trading experience, so the rule is intended to prevent traders with small accounts from engaging in day trading without sufficient experience and capital. The rule does not apply in the following scenarios:

• The trader is a non-US resident or has a brokerage account outside the US.
• The trader is using a cash account (not margin account).
• The trader is trading a market other than stocks (forex, futures, or options, for example).

If a trader engages in pattern day trading without maintaining the required minimum account balance, the brokerage firm may restrict their trading activities or close their account. Therefore, traders who plan to engage in day trading must understand the Pattern Day Trading rule and the requirements for maintaining a margin account.

Pattern Day Trading Rule Examples

Here are a few brief examples of how the PDT rule works.

$20,000 Margin Account

Let’s say you have a margin account with $20,000 and you buy and sell the same stock four times in a single trading day. This means you have engaged in pattern day trading because you have made more than three day trades within a rolling five-business-day period.

You may be restricted from taking more trades, or your broker may ask you to deposit more money in order to bring your account balance above $25,000.

$30,000+ Margin Account

Assume you have a margin account with $30,000 and you buy and sell a stock twice in a single trading day. You then repeat this activity on the following day, buying and selling the same stock twice again. You have engaged in pattern day trading because you have made four day trades within a rolling five-business-day period.

As a result of the pattern day trading activity, you would be required to maintain a minimum account balance of $25,000 in order to continue day trading. Since your account balance is currently above the minimum requirement, you would be able to continue day trading.

$5,000 Margin Account

Now assume you have a margin account with $5,000 and you buy and sell a stock twice on Monday, once on Tuesday, and once more on Wednesday.

This means you have engaged in pattern day trading because you have made more than three day trades (in this case, you made four) within a five-business-day period.

As a result of the pattern day trading activity, you would be required to maintain a minimum account balance of $25,000 in order to continue day trading. Since your account balance is below the minimum requirement, your brokerage firm may restrict your trading activities, ask you to deposit more money, or even close your account (usually after a warning).

How to Avoid the Pattern Day Trading Rule

The patterns day trading rule only applies in certain circumstances, so there are several legal ways around it.

Here are some of the ways in which you can avoid the PDT rule if you are a US resident trading stocks in a margin account.

Trade a Market Other Than Stocks

This is the best and most efficient way to avoid the pattern day trading rule. Stocks aren’t the only game in town. Forex, futures, and options are all great markets that you can day trade without the PDT rule applying. That means you can day trade these other markets as much as you want without the minimum $25,000 account balance that day trading stocks in the US requires.

These markets are also inherently leveraged, or the broker provides leverage (in the case of forex). You can also go long or short on these markets without restriction.

If you have less than $25,000 and want to day trade in the US, these other markets may be a good choice. The only downside is you may have really wanted to day trade stocks in particular. In that case, keep reading for how to avoid the PDT rule while still day trading stocks.

Trade in a Cash Account

This is the simplest way to avoid the PDT rule while still trading stocks, but keep in mind that trading with a cash account also restricts what you can do. The PDT rule only applies to margin accounts. Margin accounts allow you short stocks and also trade with leverage. Cash accounts don’t allow this.

A cash account means you are only trading your own money, so you can do what you want with it. Unfortunately, when you trade in a US cash account, each of your transactions needs to “settle”. That means you won’t have access to the funds used on transaction from the transaction date plus two business days (T+2).

Cash accounts also can’t short stocks, but you could buy inverse ETFs that go up as the underlying asset goes down. This allows you profit when prices go down which replicates shorting (but isn’t, because you are buying something, not shorting it).

These cash account guidelines apply to US residents trading stocks. If you’re outside the US, or trading a market other than stocks, the PDT doesn’t apply to you anyway.

Day Trade with Multiple Brokers

This is a more complicated way to avoid the PDT rule. Your broker tracks your trades made with them. If you make four or more day trades in a five day period with less than $25K in the account you will be flagged and you’ll be forced to stop day trading.

However, there is no national central database that is tracking all your trades. Therefore, you could split your capital between multiple brokers. This would allow you to take up to three day trades, per brokerage account, every five days. You can open various margin accounts, utilize leverage, and you’ll be able to short.

Track your trades carefully, though – if you get flagged for day trading (4 day trades or more in a five day period) with less than $25K you won’t be able to use that account for day trading anymore.

Open An Account Outside the US

The PDT rule applies to US residents trading stocks. As mentioned, you can simply trade another market with a US account…or, alternatively, you could open an account outside the US.

This may not work in some cases. Assuming your ID says you live in the US, many reputable international brokers may still hold you accountable to US law or may redirect you back to their US branch to open your account (if they have one).

Because the US has strict financial regulations, many brokers outside the US don’t accept US clients. While exploring overseas accounts is an option, the three previous methods are likely better choices.

Consequences for Violating the PDT Rule without $25,000 in the Account

The consequences for violating the pattern day trading rule aren’t severe, but they are a hassle.

If you take too many day trades with less than $25K in your account, you aren’t going to jail. Generally, your broker will send you a notice saying that you are flagged as a pattern day trader and therefore you must increase your balance to $25K or stop day trading.

You may also be restricted from opening new positions. After multiple violations, the broker may close your account. Each broker has different protocols. Check their website to see how they handle the PDT rule.

Some may suspend the account for a period of time, others may simply give a warning. Brokers have some discretion in this regard. It’s possible they may flag you as a pattern day trader even if you have NOT made four day trades in a five day period.

If they see you regularly making day trades with less than $25K – even without hitting the 4-day-trades-in-5-days limit – they can still tell you to stop or suspend or terminate your account. It’s up to the broker’s discretion and interpretation of the PDT restrictions.