How to Avoid Pattern Day Trading

Avoiding the classification as a pattern day trader (PDT) is important for traders with less than $25,000 in their brokerage account, due to the Financial Industry Regulatory Authority (FINRA) regulations.

These regulations restrict PDTs to a minimum account balance of $25,000, which imposes a limitation on the number of day trades that can be made within a rolling five-business-day period.

Key Takeaways – How to Avoid Pattern Day Trading

• Extend Holding Periods
  • Aim to hold positions for more than one day.
  • This simple strategy avoids the pattern day trader (PDT) rule by not executing four or more day trades within five business days.
• Utilize Swing Trading
  • Shift towards swing trading strategies that capitalize on trends over several days to weeks, thereby naturally avoiding the PDT classification.
• Trade in a Cash Account
  • Use a cash account instead of a margin account to bypass the PDT rules, as these regulations specifically apply to margin accounts.
  • Trading must be done within the available cash without leveraging.
• Other Strategies
  • Diversify accounts (multiple brokers).
  • Use brokers that provide PDT flexibility.
  • Other forms of trading.
  • Trading on non-US exchanges.
• Compliance
  • An obvious one, but sometimes simply complying with the $25,000 minimum is easiest. The regulation is designed to reduce risk for traders.

How to Avoid Pattern Day Trading

Here are strategies to avoid being classified as a pattern day trader:

Limit Day Trades

Ensure you don’t execute four or more day trades (buying and selling the same security on the same day) within a rolling five-business-day period.

Keeping your day trades to a maximum of three within five business days is important.

Use a Cash Account

Trading in a cash account bypasses the PDT rule, as this rule applies only to margin accounts.

However, trading in a cash account requires you to adhere to the T+2 settlement rule, meaning you can only trade with settled funds, which takes two business days after a trade is executed to settle.

Swing Trading

Shift your trading strategy from day trading to swing trading, which involves holding positions for several days or weeks.

This approach not only circumvents the PDT restrictions but also may align better with broader market trends and reduce transaction costs.

It may also reduce the time intensity associated with day trading, given the trades are less frequent and held longer.

Diversify Accounts

Opening multiple brokerage accounts – with different brokers – can technically allow for more day trades since the PDT rule applies on a per-broker basis.

But this strategy requires careful management to avoid violating any broker’s terms and potentially complicating your financial strategy.

Use a Broker That Offers PDT Flexibility

Some brokers offer specific accounts that provide more flexibility with the PDT rule.

For example:

• Cash Accounts – As mentioned, with cash accounts trades settle on a T+2 basis (trade date plus two business days), limiting you to settled funds. However, PDT restrictions don’t apply.
• Offshore Brokers – Brokers outside US jurisdiction might not enforce the PDT rule at all.
• Portfolio Margin Accounts – These often have relaxed PDT restrictions, but require larger account balances (north of $100,000) and a higher level of trading sophistication.

Thoroughly research the pros, cons, and potential risks of each account type before choosing one that aligns with your trading style and goals.

Focus on International Markets

If feasible, consider trading in markets outside the United States, as the PDT rule is specific to US stock markets.

International markets may have different regulations and opportunities.

Try Other Forms of Trading

Futures trading isn’t subject to PDT rules.

You can actively trade futures contracts without worrying about day trading restrictions.

Just remember that futures involve leverage and higher risk.

Education and Simulation

Enhance your trading skills and strategies through simulators and practice accounts.

Engaging in education and using trading simulators allow traders to refine their strategies and test their market approaches without risking real capital or making actual trades that could classify them as PDTs.

Comply with PDT

Compliance can be straightforward by maintaining a minimum account balance of $25,000, as required by regulation to minimize trading risks.

It’s also hard to day trade without a decent capital base.

FAQs – How to Avoid Pattern Day Trading

What is a pattern day trader (PDT)?

A pattern day trader is an individual who executes four or more day trades within a rolling five-business-day period in a margin account.

The Financial Industry Regulatory Authority (FINRA) imposes regulations on PDTs, including a minimum account balance requirement of $25,000.

Why might someone want to avoid being classified as a pattern day trader?

Someone might want to avoid being classified as a pattern day trader to circumvent the $25,000 minimum account balance requirement and the restrictions on the number of day trades they can perform within a given week.

This can limit trading flexibility for individuals with less capital.

Can I day trade with a cash account to avoid PDT restrictions?

Yes, trading in a cash account can bypass the PDT rule, as this rule applies only to margin accounts.

However, cash account traders must adhere to the T+2 settlement rule, which requires waiting two business days for funds to settle after a trade before those funds can be used again.

What is swing trading, and how does it help avoid PDT restrictions?

Swing trading is a strategy that involves holding positions for several days to weeks, as opposed to opening and closing positions within the same day.

This approach avoids PDT restrictions by not engaging in day trades.

This trading style can also align more closely with those interested in trading longer-term market trends.

Is it possible to manage multiple brokerage accounts to avoid PDT rules?

Technically, yes. Since the PDT rule applies on a per-broker basis, having multiple brokerage accounts could allow for more day trades across accounts.

Nonetheless, this strategy requires careful management and adherence to each broker’s terms and conditions.

How does trading in international markets help avoid PDT rules?

The PDT rule is specific to US stock markets.

By trading in international markets, traders can potentially avoid these restrictions.

It’s still important to understand the regulations and conditions of the international markets you’re considering.

If I’m a US-based trader and trade international stocks instead of US stocks, am I subject to PDT?

If you’re a US-based trader trading stocks exclusively on a non-US international exchange, then the PDT rule does not apply.

Your trading activity would be governed by the rules and regulations of the specific exchange and your broker.

Things to Know

• Broker Restrictions – Some US brokers may still impose restrictions on your account even if you trade on international exchanges.
• Margin Accounts – Using a margin account might still trigger PDT-like rules depending on your broker.
• Research – Always check with your broker about specific rules and restrictions before trading on international exchanges.

Conclusion

We realize the PDT rule can be inconvenient and avoiding the PDT classification can be beneficial for traders with limited capital, but it’s also important to understand the rationale behind the rule: to protect investors from excessive risk.

Hence, regardless of your strategy, risk management should remain a priority.