Update to the Pattern Day Trader (PDT) Rule Makes Life Tough For Retail Traders

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Update to the Pattern Day Trader (PDT) Rule Makes Life Tough For Retail Traders


 

FINRA just made updates to their pattern day trader (PDT) rule that punishes violators much more harshly. 

Here’s a quick rundown on what that means:

  • The Pattern Day Trader (PDT) rule allows for no more than three (3) day trades within a rolling five day period, if the account has less than $25,000.
  • Before this update, violations of the rule resulted in the violating brokerage account being blocked from opening new trading positions for 90 days (with some case-by-case exceptions). Each violation would result in a ‘flag’ on your account. Previously, brokerage accounts could get three flags per year.
  • The rule is now updated, allowing only one violation per account for the life of the account. For example, if you violated the PDT rule once, (i.e., you made more than three day trades in a five business day period), and then did it again, your brokerage account would be permanently ‘flagged’ as a pattern day trader, meaning that you wouldn’t be able to open new positions until you bring your account balance to at least $25,000.

So to use an electronics term, your brokerage account is “bricked” if you violate the PDT rule more than once throughout the entire life of your account.

The only way to bring your account to good standing again would be to deposit enough cash or securities to bring your account balance up to $25,000. Your only other option would be to transfer your cash to a new brokerage account at a new broker. 

This is part of a pattern of crackdowns on retail trading and the brokerages that target them. The new SEC chair Gary Gensler has made no secret about his desire to institute new regulations on brokers like Robinhood and his general skepticism around the business model of retail stock brokers.

What To Do Now? How To Get Around the PDT in 2021?

Go to any stock trading forum and the PDT is discussed ad nauseam. Whether its political discussions about the rules merits, ideas to skirt the rule, or how to alter your strategy to live with the rule, it’s always on the mind of new traders. 

In our mind, there’s two simple ways to deal with the PDT when you’re an undercapitalized trader. The first is opening multiple brokerage accounts at different firms, and the second is to stop day trading so often and start swing trading and holding stocks overnight.

Opening Multiple Brokerage Accounts

You can spread your capital around a few different brokerage accounts and get three day trades for each account. Even better, if you make a mistake and accidentally get the PDT designation on one account, you already have backup accounts setup with cash in them. 

The drawback is that you’re spreading an already thin capital base across multiple accounts. This can be okay if you’re trading highly volatile low float stocks, because your position size is already likely to be smaller than your account size because of the massive percentage moves these things make.

Changing Your Trading Style

Most aspiring day traders sigh when they’re told to change their trading style due to the PDT rule. But think about it for a second. The size of price moves scale up as you broaden your time horizon. You can be making much larger gains by simply holding overnight and not watching every tick. 

This is especially advantageous if you trade large-cap stocks. Large-caps don’t move that much. It’s rare to see a large-cap name move more than 10% intraday outside of earnings reports. However, it’s far less rare to see a 10% move over the course of a few days in a large-cap that has some momentum. 

Even a stock like Google (GOOG), one of the largest companies in the world, just made an 8% move in the span of eight trading days recently.

PDT Update

 

So while day trading large-caps with a small account might bring you 0.5% gains on your average gains, you can get several multiples of that by being patient. 

Of course, when it comes to low floats, these are much riskier to hold overnight and best left to the experts who have been in this game for a while and understand the risk/reward and market dynamics better.

But who said you can’t make a few day trades a week on low floats while supplementing that with some more conservative large-cap swing trades?

Who is FINRA?

FINRA is the Financial Industry Regulatory Authority. They’re not a government agency, but a ‘self-regulatory organization.’ They act as a quasi-governmental agency to regulate the securities industry.

The basic idea is: the SEC writes securities laws and FINRA regulates financial firms and ensures they’re following the laws. FINRA takes care of the day-to-day to ensure compliance while the SEC is in charge of the big picture stuff. 

Because FINRA regulates broker-dealers and their registered reps, they’ve made their own additional set of rules and guidelines that brokers have to follow in order to keep their license. One such rule is the Pattern Day Trader (PDT) designation, which forces brokerages to limit the amount of day trading that small accounts can do. 

As any governmental agency (or in this case, self-regulatory organization) does, they often update their rules to reflect the world changing around them.

All of that crazy media attention garnered by WallStreetBets’ gambling style of trading probably led FINRA to clamp down on retail traders harder, because the media headlines following massive losses by retail traders typically carry a tone of wishing for more regulations to protect investors from themselves.

The Backlash Against Retail Traders

The rise of trading-related discussions on social media makes retail traders a pretty powerful bunch. In previous years, retail traders were ignored as dumb money, or “noise traders.”

It was a popular trading meme to “inverse” the popular retail trading stances, or, in other words, if retail really liked a stock, it was in vogue to short the stock or close your long position. 

But the convergence of several trends, like lockdowns (see: Boredom Markets Hypothesis), and the rise of WallStreetBets gave retail traders the ability to collaborate and follow each other into trades, leading to fiascos like GameStop, AMC, and the other short squeeze manias.

The rise in power of retail traders as a group serves to threaten the old guards of market power, and of course they’re going to take steps to ensure that they’re not caught flat-footed again.

This isn’t the first rule change that directly affects retail traders lately either. We recently wrote about an SEC rule change that affects retail investors who operate in the niche corner of OTC “Gray Market” stocks.

Bottom Line

It’s unlikely that any amount of online petitioning or comment-writing will get FINRA to flip flop on this issue. They’ve made their decision and your broker is forced to comply with the rule change and enforce it against you if you violate it. 

So the only thing to do here is to adapt. You can use this as motivation to get your account balance over $25,000, or to modify your trading style as to not be affected by the PDT at all.

Either way, keep in mind that if you’re in the trading game for the long haul, this PDT business is temporary.

Eventually, with good trading, your account will be over $25,000 and the PDT will be an afterthought, so don’t grant it too much mental real estate.



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