An early 2000s rule intended to protect small investors from the risks of day trading is no longer.
The Pattern Day Trader (PDT) rule was established in 2001 by the Financial Industry Regulatory Authority (FINRA) when regulators worried about small investors taking big risks. The rule also held active traders to higher standards than those who traded far less frequently.
Flash forward 25 years, however, and FINRA is ditching the dot-com-era rule in favor of a more modern system. Here’s how the change will affect day traders and brokerage firms — and what you need to know about the new stipulations.
The PDT rule labels anyone who makes at least four day trades within five business days — and those trades account for more than six percent of their overall account activity — a “pattern day trader.” Once labeled a “pattern day trader,” the account holder has to maintain a minimum equity of $25,000 in their account at all times. (1)
If a PDT starts the day below the $25,000 minimum equity and executes a day trade, they’d be limited to liquidating trades only.
Some brokerage firms like Charles Schwab (2), for example, may allow one-time exceptions for flagged clients, so long as those clients commit to not repeating the aforementioned day-trading pattern.
In addition to the account minimum, PDTs cannot trade in excess of their day-trading buying power, which is generally up to four times the maintenance margin excess as of the prior day’s business close.
If a PDT does exceed the outlined limitation, the firm must issue a day-trading margin call, after which the PDT has, at most, five business days to deposit funds to meet the call. Until then, their account will be restricted to a day-trading buying power of only two times the maintenance margin excess. (1)
If a pattern day trader fails to deposit the funds within five business days, they’ll be permitted to execute transactions only on a cash available basis for 90 days (3) — or until they meet the special maintenance margin.
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Supporters of the PDT rule say that it’s more important than ever as younger, unsophisticated investors continue to trade more aggressively without the necessary experience to navigate the markets successfully. Often influenced by social media — and online personalities like “finluencers” — inexperienced traders may take on too much risk without that $25,000 requirement.
Critics of the rule, however, argue that it has created barriers to entry for small investors, serving more as an evaluator of a trader’s wealth than protecting them.
Critics also argue that the rule is now antiquated — including Anthony Denier, the U.S. CEO of retail broker Webull, who told Forbes (4) that retail investors are “more informed” these days with more advanced tools. After all, the rule was written before the age of zero-commission trading apps and easy access to real-time market data.
Brokerage firms that cater to more novice investors who tend to have lower balances — such as Webull and Robinhood — are well-poised to see more trading activity without the rule in place. Likewise, for new retail investors who want the flexibility, the change is a major benefit.
FINRA will eliminate the current day trading margin requirements, including the definition of “day trading” and “pattern day trader.” It will also eliminate the computation and use of day-trading buying power, and the $25,000 minimum equity requirement, replacing those provisions with intraday margin requirements instead.
FINRA believes that the proposed rule change will reduce risk while giving customers more flexibility to participate in the markets — and cut back on compliance costs. (3)
Going forward, brokerages will be able to monitor accounts in real time and block trades that would create a margin deficit, which shifts the focus from how many trades a person makes to whether or not their account has enough money to support the risk involved.
Firms can also calculate whether or not traders fall short on a daily basis. Account holders who don’t fix their shortfalls (of at least $1,000, or five percent of their account size) within five business days will lose access to more borrowed money for up to 90 days.
Firms will have 45 days after FINRA publishes its formal notice to begin implementing new risk-based margin systems for smaller accounts. They have 18 months to fully phase in those new systems.
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Financial Industry Regulatory Authority (1); Charles Schwab (2); Federal Register (3); Forbes (4)
This article originally appeared on Moneywise.com under the title: FINRA just killed the $25,000 day-trading rule that kept small investors on the sidelines for 25 years
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
