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Day Trading really gained popularity in the booming stock market of the 1990’s. It seemed everyone was trying to get in and out of securities and make a profit on an intraday basis. The popularity of day trading certainly has its highs and lows with investors based on how well the market is doing, but there are still plenty of day traders in today’s environment. In 2001, the SEC and FINRA moved to create a new “Pattern Day Trader” rule which changed the rules and requirements that surround the process of day trading. In this article, let’s first take a look at exactly what the “Pattern Day Trader” rule  is and how it changes the day trading landscape. Then we will look at the reasons why the SEC implemented this rule. Finally, we’ll examine some of the common complaints that investors raise about the rule.

What is the Pattern Day Trader Rule?

The rule was put in place in late 2001. A “Pattern Day Trader” is described by the SEC as “any customer who executes four or more day trades within five business days, provided that the number of day trades represents more than six percent of the customer’s total trades in the margin account for that same five day business period.” Under these rules, a pattern day trader must maintain a minimum of $25,000 in their margin account on any day that they day trade. If the account falls below $25,000 at any time, the pattern day trader will not be allowed to day trade until the account is restored to the $25,000 threshhold. The rules also permit a day trader to trade up to four times the maintenance margin excess in the account as of the close of the previous trading day. If the pattern day trader exceeds this limit a margin call is issued, and they will have the amount limited to two times the excess amount. If the margin call is not met by the fifth business day the account will be restricted to trading on a cash only basis for 90 days or until the margin call is met.

Why Was the Rule Implemented?

The SEC believes that while all forms of investing are risky, day trading is an especially high risk practice. The pattern day trader rule was said to be put in place to limit potential losses and protect the consumer. Why the $25,000 minimum account requirement? The SEC believes that those whose account value is less than $25,000 are likely to be less sophisticated traders. The SEC and FINRA decided that previous day trading rules did not properly address the inherent risks with day trading. The pattern day trader rule aimed to foster an environment where day traders were well-aware of the risks associated with this type of investing.

Common Arguments Against This Rule

The pattern day trader rule is not popular at all among day traders. Here are some of the most common arguments against the pattern day trader rule.

  • The rule goes against the entire idea of free markets. Many argue this is a case of the government trying to protect the traders from themselves.
  • The rule actually makes a trader with $25,000 or less move to even more risky markets, such as the futures market. While the SEC says it was trying to protect these investors, it might actually be pushing them into even more highly leveraged investments.
  • The rule limits the ability of a day trader to diversify, which makes risks in day trading much higher than they previously were.

All in all, the pattern day trader rule was designed to protect investors and is enforced by every major online brokerage as according to law. For investors wanting to day trade and take advantage of added margin leverage, a minimum of $25,000 must be in the account at the start of each trading day. Otherwise, investors have to stick to the buy and hold style, holding securities atleast overnight before selling.

Special Feature: Read our guide to the Best Brokers for Day Trading.