How to Avoid the Pattern Day Trader Rule

Investors who want to close out every position before the end of the session often wonder about how to avoid the pattern day trader rule. The SEC is rather strict about making sure anyone who comes under the definition of day trader is required to maintain a $25,000 balance and adhere to a few other guidelines. But what about casual traders who only make a day trade now and then, but who want to avoid falling under the official definition?

The good news is that there are ways to avoid getting a dreaded notice from the SEC telling you to bring your balance up to snuff or risk being frozen out of the market for 90 days. In fact, anyone can avoid getting such a greeting from the federal authorities by following a few simple strategies.

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Keep Your Account Balance High Enough

The most obvious way to avoid any of the hassles of being warned by the SEC is to keep a large enough balance in your brokerage account. For most market enthusiasts, $25,000 is a pretty big chunk of change but if you can swing it, you’ll never have to worry about a warning letter. The thing to remember is that the pattern rule only applies to margin accounts, not cash balances in excess of $25,000.

Keep Accurate Records

If you can’t afford to leave a lot of money in your brokerage fund, be sure to keep accurate records so you always know how many round-trip trades you’ve done. One or two in a week will keep you in good standing, but once you venture into a third or fourth position that closes out within a single trading session, you’re skating on thin ice. Meticulous record-keeping is the answer. Always know where you stand with every buy or short-sale you make, and keep careful track of how many round-trips you do within a week.

Be Careful with Stop Orders

Stop orders can be a smart way to protect capital. If a security’s price falls too much, you are automatically removed at the stop-order price before shares sink to dangerous depths. But keep in mind that stop orders can cause you to sell within a few hours of buying, which triggers a day trade on your books. Whenever you place a stop with an order, make a special notation in your logbook and keep an eye on the position for an unexpected sale.

Talk with Your Broker

Tell your broker that you are not intending to be a day trader but may inadvertently make such trades now and then. That way, if you ever break the rule by going over the limit, your broker will know that it was an accident and will likely not impose a three-month freeze on your activity.

Don’t Use a Margin Account

The trading rule for pattern activity only pertains to margin accounts. If you only operate with cash, you have nothing to worry about. The SEC created the rule for the purpose of counterbalancing the high levels of risk that short-term buying and selling can entail. Cash buyers and sellers aren’t at risk for huge margin percentages, so they have no need for regulatory protection.

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