First of all, let’s assure you the pattern day trading isn’t illegal, certainly not in the UK. In the United States, things are a little different, but even there, it isn’t entirely illegal; it is just subject to some arbitrary rules.
However, to clarify what we are talking about, we will explain what pattern day trading is all about, how it is viewed by the US Financial Industry Regulatory Authority (FIRA), and the situation regarding day trading in the UK.
What is a Pattern Day Trader?
Pattern day trading applies to all financial securities. Any trader may be designated as a pattern day trader by FIRA if they:
Execute four or more day trades over five consecutive days in a margin account, AND the number of day trades is greater than 6% of the total trades in their account over that period.
If this is the case and they are designated as such, then:
They are obliged to maintain a minimum balance in that account of $25,000, which may be a combination of cash and securities. The balance must reside in the account before the start of day trading activities.
It is essential to note that the designation applies only to margin accounts; it doesn’t include cash accounts. In this context, a day trade is when the trader opens and closes in a single day; we usually refer to this as a round trip. If the position is held overnight, it is no longer considered to be a day trade.
Once a trader has been designated as a pattern day trader, they must refrain from day trading for three months to reverse that designation, in other words, to achieve normal trader status and to be relieved from the requirement to maintain a $25.000 balance.
Additional Pattern Day Trader Rules
While we have already said that pattern day traders must retain $25.000 equity in their accounts, some additional rules apply:
If the pattern trader account falls below $25,000 equity, the broker will issue a margin call to restore the minimum equity requirement through a cash deposit or other equities. The deadline to meet the margin call is five business days.
Furthermore, the minimum equity funds cannot be withdrawn from the account within two business days. Also, cross guarantees are not permitted; in other words, each day trading account must independently meet minimum equity requirements with funds deposited in that account.
If a day trader fails to comply with these requirements in any way, their broker will restrict their account for 90 days or until they meet the margin call.
Pattern Day Trading in the UK
There is no such designation as a pattern day trader in the UK, so if you are trading through a UK broker, you can forget all about the FIRA rules and designations. In the UK, day trading is regulated through FCA (Financial Conduct Authority) regulations.
But if you decide to day trade on the margin, you should be aware of the potential dangers. While there are potentially significant gains to be made, there is also the danger of substantial losses. The fundamental reason FINRA introduced the pattern day trading rule in 2001 was to protect investors from losing money.
The reasoning was they wanted to make it harder for new traders to start day trading; it would be better, the authorities thought, to encourage them to buy and hold stocks for an extended period. In other words, they considered it bad practice to trade based on chart patterns; it was far better to make appropriately informed investment decisions.
But that ethos is debatable. We have failed to locate any peer-reviewed evidence that buying stock based on recommendations is safer than pattern trading. Of course, you could argue that you have far greater control of your investment with pattern trading. But as they say, the rules are the rules.
Leverage Restrictions in the UK
In the UK, retail traders are protected to some extent from excessive losses by restrictions on the leverage available to them. The FCA caps the leverage available to retail traders. For instance, a broker might offer maximum leverage on a retail account of 30:1 while offering 500:1 on a professional account.
Unless you are trading through a broker registered with FIRA, pattern day trading rules don’t apply to you. You are free to day trade as much as you wish; there is no limitation on the number of closed-circuit trades you can make.
However, if you are trading on the margin, ensure you know the increased risks compared to a cash account.