According to the Securities and Exchange Commission (SEC), a pattern day trader is a person who executes at least four day trades in a five-day period. These day trades must account for at least six percent of the total trading activity during this five-day period. Because day trading exposes a trader to a number of dangers and can result in unethical behavior, the SEC has placed specific requirements and restrictions on pattern day trading.
Some of the rules in place from the SEC include those that protect margin customers from the intra-day volatility of the trading system. In order to conduct pattern day trading, a margin account must maintain a balance of at least $25,000 US Dollars (USD). Additionally, this account must be in place before a pattern day trader can conduct any trades. However, brokerage firms do not have a responsibility to monitor or confirm that the minimum equity is maintained in the account on a daily basis.
Exchange Rule 431 regarding margin requirements is responsible for establishing additional rules about pattern day trading. This rule states that when the amount of day trades falls below the six percent minimum, despite the number of trades, the trader will cease to be considered a pattern day trader. However, any person conducting occasional day trades will immediately be considered a pattern day trader when the criteria is met. Brokerage firms that believe a client will conduct these trades must register the customer as this type of trader immediately. This means that the firm does not need to wait for five business days to see what the customer does. Once classified as a pattern day trader, three months must pass without a viable day trade in order for the restrictions to be removed.
One major facet of pattern day trading is the concept of the “round trip.” When a trader purchases and sells the same stock three different times in the matter of one day, a “round trip” has taken place. If this occurs more than once in a four-day period, the account must be frozen for 90 days.
Pattern day traders are subject to so many rules due to a desire by the SEC to make sure that the people conducting these trades understand their actions. Opponents to the regulations claim that these rules provide undo governmental oversight and limit the rights of traders. However, due to a number of unethical actions by day traders throughout the 1990s, the SEC decided to institute rules regarding pattern day trading in 2001.