Pattern Day Trader
The market has been wildly volatile lately. We’ve witnessed swings as large as 800 points in a single direction.
What’s more, the market is down more than 2,000 points since September 2, 2008.
Given these huge price movements, it has become more risky than normal to leave option positions open overnight… and especially risky to leave positions open over the weekend (have you seen the huge gap downs the last few Monday mornings?).
But here’s the thing. If you close positions too often, you could get tagged as a “pattern day trader.”
A pattern day trader, defined by Exchange Rule 431, is “any customer who executes 4 or more round-trip day trades within any 5 successive business days.” Source: Wikipedia
There is an exception:
If, however, the number of day-trades is more than 3 but is 6% or less than the total number of trades that trader has made for that five business day period, the trader will not be considered a pattern day trader and they will not be required to meet the criteria for a pattern day trader.
The bottom line is you can be classified as a pattern day trader if you open and close positions too frequently. And if this happens, you will have to adhere to a set of onerous rules.
For instance, if you get tagged as a pattern day trader, you will immediately be required to maintain at least $25,000 of equity in your trading account at all times. If your balance ever falls below this level, you will face an immediate margin call to bring your account up to the minimum equity level.
These rules make it nearly impossible for beginners to be day-traders or even swing traders.
So, if possible, it makes sense to avoid too many round-trip day trades in a week.
On the other hand, the risk is still there. With the market swinging hundreds of points in both directions, you are exposed to big potential losses when you keep positions open overnight.
So what do you do?
While I can’t give you specific advice, I can share what we’ve been doing here at Trading Trainer. And I will share that strategy with you in the next post. Watch for it in the next few days.
Best regards always,
A.J. Brown
gerard @ 11:43 am:
Just got your package and am anxious to get started and become efficient in becoming an option trader. I intend to papertrade for a while and see how I am doing following the rules to the utmost.
Gerard
fred @ 5:09 pm:
I look forward to your next article. I often want to day trade but don’t because of this rule. If I placea a couple of trades and get stopped out.. Bang! I may become a pattern day trader.
RJ @ 2:53 am:
Good subject , it grabbed my attention instantly. Waiting for your next comment to get to know your strategy so please send it soon , since we never know when this market will normalize again.
A.J. Brown @ 9:25 am:
@Gerard - Thanks for the comment. I think you’ll enjoy the training material.
@Fred - Yep. That’s the concern.
@RJ - Next article will be out today or early next week.
JerryV @ 12:02 pm:
How does the rule effect you if you don’t use margin in your trading?
Bob Knapp @ 5:29 pm:
I have been a stock day trader since July - switched from exclusive options trading. I do have 25K (not a whole lot more, since I’ve lost more than 6 times that amount since 05. That’s why I’m studying with AJ as well as others). In any event, I just wanted to share a couple items.
1 - I do not overleverage my account - I never risk more than a couple hundred dollars (usually just one hundred). My risk/reward is 2-1, but I get out if I see the charts moving against me, even if he profit is small.
2 - I have an unusual stop gap measure that I use in the event my position moves against me too quickly and my loss is over a couple hundred, Rather than take a loss, I sell a call against my position. Does it limit my profit if the stock once again reverses? Yes, but I don’t mind - the premium I collect lowers my cost basis. More importantly, I can relax. I do not use margin with my long position (i.e., my position is less than 25K).
My use of margin is primarily for short selling.
If I retain my position overnight, I am precluded from day trading - but that’s OK - a couple days off is alright - and I can trade options with the remainder of the cash.
3 - In the event that I must employ the above, I wait until I can buy back the call (when stock hits support).
Then I’ll ride the stock back up to resistance and sell it.
Keeping expectations low is the key - my time in trade is usually just a few minutes (15) - I’m back in cash, and can go about my business.
I know this sounds a little convoluted but I am a nervous nellie, so it is perhaps more psychological than economically efficient. I found that I was selling way too soon - this allows patience and precludes overreacting.
Of course, this is not what AJ teaches - I would like to build my account to the point where I can trade with his methodology and be more mechanical. It’s just another way of trading.
OTM Near-Term Vertical Debit Spreads @ 9:40 am (Pingback)
[...] catch? If you open and close too many positions in a single week, you will be tagged as a pattern day trader, and forced to comply with a set of complex and onerous [...]
Joshua Hayworth @ 12:58 am:
Does this only apply to trades made on the New York Stock Exchange? Does this also apply to NASDAQ (or any other exchange for that matter?)
The reason I’m asking is because I found this reference over here: http://www.sec.gov/rules/sro/nyse/2006/34-54125.pdf
The paper makes mention of an addendum to “NYSE Rule 431″.
It would be nice as I only plan to trade on NASDAQ and CBOE (at least to start).
Google Search: http://www.google.com/search?q=Exchange+Rule+431
A.J. Brown @ 9:57 am:
Hey Joshua,
From what I understand, the pattern day trader ruling is a SEC ruling across the boards.
Next time I’m talking with my contacts at brokerages, I’ll ask for clarification.
Thanks Joshua for your question.
Tom @ 11:12 am:
Hello A.J.,
I had a question about what exactly counts as a day trade in regards to trading options. Are each of the different Calls and Puts for a specific underlying stock considered to be different securities? What I mean is, say for example I held an AMZN 40.00 Call overnight and sold it the next day, if I were to then buy an AMZN 42.50 Call during the same day, would this be considered a day trade or are the 40.00 Call and 42.50 Call considered to be separate securities. Thank you for your help.
-Tom
Day Trading Books @ 8:05 pm:
Thanks for sharing your thoughts with us. I appreciate the time and effort you went to in order to provide valuable information, rather than much of the junk I have seen around the ‘net.
Kind regards,
Barry