Due to an overwhelming request of questions about Pattern Day Trader Rule I have decided to write this post to look at these issues. Whether you know about it or not, you don’t want to accidentally learn about Day Trader Status by a notice from your brokerage firm saying that you are now tagged as a Day Trader.

What is a Pattern Day Trader?

A Pattern Day Trader is someone who does four intra-day trades in five consecutive trading days. Let me address some terms here to help you understand this better:

Intra-day trade: A trade that is opened and closed in the same trading day (round trip).

Five Consecutive Trading Days: These are calendar days that the market is open, all in a row.

For example: If the market was open on Monday through Friday that would be five consecutive days. Then we would have Tuesday through Monday for the next five consecutive days (unless Monday was a holiday in which case it would then be Tuesday through Tuesday. Next, we would have Wednesday through Tuesday, and so on. The key is five trading days in a row.

How To Avoid It

One of my¬†friends¬†taught me to use a calendar to record my intra-day trades. By placing an “X” on the day you do intra-day trades, (2 X’s if you do two, 3 X’s if you do 3 in that day) you can avoid accidentally getting to four by looking at your calendar. Make sure you mark the days the market is closed on your calendar.

Why Does It Matter?

I thought it mattered a lot, but after my research for this blog, it appears there actually are some great benefits being classified as a “Day Trader” if the $25,000 is not an issue for you. Basically, there are two issues at hand:

Your brokerage firm will likely impose the NASD requirements of maintaining at least $25,000 in your trading account – and you have 5 days to comply. If you have this kind of money there is no issue. However, if you are starting out with limited funds to trade it could be a big issue. One important note – always ask for one time of forgiveness. The penalty for not complying is that you are subject to cash only trades.

There is a really incredible benefit though if you are tagged a Day Trader and maintain the $25,000 minimum value in your account. You may be eligible for day-trading margin, which is 4 times account buying power. This buying power may only be used intra-day and may not be held past market close. Orders exceeding Day-Trading Buying Power will be rejected.

Tax Consequences with the IRS

Upon research into the IRS Publications, it does not appear as bad as I thought. A tax firm specializing in trading activity, says:

  • They allow a full deduction of all trading losses in the year they occur, thereby circumventing the historical $3,000 net capital loss rule.
  • They allow full current expensing of trading expenses without limitation, thereby circumventing the limitation on miscellaneous itemized deductions.
  • They enable the active trader to still take advantage of the beneficial long term capital gain rules.
  • They enable the active trader to circumvent the restrictive “Wash Sale” rules normally applied to investors, thereby alleviating a huge record-keeping nightmare.
  • They allow the active trader to deduct losses on open as well as closed positions.

The proper classification of your investment activities is important to determine how income and expenses are to be reported.

Traders that buy and sell securities frequently can report their purchases and sales result in capital gain and loss, and their deductible expenses are trade or business expenses.