1.10 The Rules That Govern Retail

Understand the regulatory rules that specifically affect retail traders — PDT, wash sales, round-trips, and Reg SHO restrictions. These rules can lock you out, cost you money, or invalidate your tax strategies if you don't know them.

Layer 1: Market Plumbing — Chapter 10 Goal: Understand the regulatory rules that specifically affect retail traders — PDT, wash sales, round-trips, and Reg SHO restrictions. These rules can lock you out, cost you money, or invalidate your tax strategies if you don't know them.

The Core Idea

The market is heavily regulated, but most rules target retail differently than institutions. Three rules in particular can blindside a new trader:

Pattern Day Trader (PDT) — limits day trading below $25K
Wash Sale Rule — invalidates tax losses
Good Faith Violations / Free-Riding — already covered in 1.6

Knowing these isn't optional. Breaking them carries real consequences.

The Pattern Day Trader (PDT) Rule

The Definition

A Pattern Day Trader is anyone who executes 4 or more day trades within 5 rolling business days, AND those day trades are more than 6% of their total trading activity in that period.

What Counts as a Day Trade

Day trade = buying and selling (or selling short and covering) the SAME security on the SAME day.

Important nuances:

Buying 100 shares of AMD in the morning and selling them that afternoon = 1 day trade
Buying 100 shares twice and selling 200 shares = 1 day trade
Multi-day position closed today (bought yesterday, sold today) = NOT a day trade

What Happens If You Get Flagged

If you make 4+ day trades in 5 business days with <$25K equity:

Your broker flags your account as PDT
You get a 5-business-day reset window to bring equity to $25K
If you don't, you're restricted to closing trades only for 90 days
The flag persists for 90 days even if you stop day trading

The $25K Threshold

To day trade unrestricted, you need $25,000 minimum equity in your account at all times. If you drop below $25K, restrictions kick back in.

Why This Rule Exists

Implemented after the 2000 dot-com bust. SEC concluded retail day traders were systematically losing money and over-leveraging. The rule was meant to slow them down.

Your Situation

With $9,000, you cannot meaningfully day trade US stocks. You get 3 day trades per 5 business days, then you're locked.

How to Avoid PDT

Don't day trade. Swing trade instead (hold overnight) — no PDT restrictions.
Trade futures. Micro contracts (MES, MNQ) have no PDT. ✓ Most popular workaround.
Trade in a cash account. No PDT, but you get GFVs instead (Chapter 1.6).
Open multiple broker accounts. Each has its own PDT count. Risky and may violate broker terms.
Wait until you have $25K+. The boring honest answer.

How PDT Counting Actually Works

This is where people get tripped up. Some examples:

Example 1: Two Round-Trips Same Day

Buy 100 AMD at 10 AM, sell 100 AMD at 11 AM
Buy 100 AMD at 1 PM, sell 100 AMD at 2 PM
= 2 day trades (each round-trip counts)

Example 2: Partial Sales

Buy 100 AMD at 10 AM
Sell 50 AMD at 11 AM
Sell 50 AMD at 12 PM
= 1 day trade (single position closed in pieces)

Example 3: Overnight Hold

Buy 100 AMD on Monday at 3 PM
Sell 100 AMD on Tuesday at 10 AM
= 0 day trades (held overnight)

Example 4: Sell Then Buy Back

Sell 100 AMD (existing position) at 10 AM
Buy back 100 AMD at 2 PM
= 1 day trade (this still counts!)

Example 5: Five-Day Rolling Window

Day	Day Trades
Monday	1
Tuesday	1
Wednesday	1
Thursday	0
Friday	1 → 4 in 5 days = PDT flag

The Wash Sale Rule

This rule is about taxes, and it can quietly destroy your year-end tax planning.

The Rule

If you sell a security at a loss and buy the same (or "substantially identical") security within 30 days before or after the sale, the loss is disallowed for tax purposes.

Example

January 5: Buy 100 AMD at $200 = $20,000
January 15: Sell 100 AMD at $180 = $18,000
Realized loss: $2,000
January 20: Buy 100 AMD at $185
Wash sale triggered! The $2,000 loss is disallowed for this year.

What Happens to the Disallowed Loss

Added to the cost basis of the new purchase
New cost basis: $185 + $20 (disallowed loss/share) = $205
So when you eventually sell with no wash sale, you get the loss back

What "Substantially Identical" Means

Same stock: definitely identical (AMD = AMD)
Different class of same company: probably (GOOG vs GOOGL)
Stock vs option on the same stock: yes, counts
Different stocks in same sector: NO, doesn't count
Different ETFs tracking similar things: gray area

The Tricky 61-Day Window

30 days BEFORE + sale day + 30 days AFTER = 61 days total.

Most people only think about the 30 days after. The 30 days before can trip you up if you bought more shares before realizing the loss.

How Wash Sales Trap Active Traders

Imagine you trade AMD constantly. By December 31:

You have $5,000 in realized losses across many trades
But because you kept rebuying AMD, all those losses are wash sales
None of them count for tax deduction this year
They're added to your current cost basis

You can't harvest tax losses if you keep trading the same name.

How to Avoid Wash Sales

Don't rebuy the same stock within 30 days of a loss sale
Substitute with a similar but not identical security (e.g., sell NVDA, buy AMD or SOXX ETF)
Stop trading the name through January 30 if you took December losses

Wash Sales in IRAs (Bigger Trap)

If you sell at a loss in your taxable account and rebuy in your IRA, the loss is permanently disallowed — it doesn't even adjust basis. Total loss of the tax benefit.

Your Broker Tracks These

Your 1099-B will show wash sales automatically. But it only tracks within ONE account. If you sell in Robinhood and rebuy in Fidelity, your broker won't catch it, but the IRS still requires you to report it.

Round-Trip Rules

Some additional rules brokers may enforce:

Cash Account 90-Day Restriction

If you commit 3 Good Faith Violations in 12 months (Chapter 1.6), you're restricted to settled cash trading for 90 days.

Day Trading Margin Calls

If you use 4× intraday buying power and don't close your position before close, you may face a day trading margin call if positions exceed 2× equity overnight.

You get 5 business days to deposit funds. If you don't:

Day trading buying power reduced to 2× for 90 days
Repeat offenses can lead to account restrictions

Reg SHO Short Sale Restriction (Recap from 1.8)

Already covered in detail, but reminder:

Triggers when a stock drops 10%+ from previous close
Lasts for the rest of that day + all next day
Short sales must be on an uptick (above current bid)
Stocks under SSR often see temporary bounces because short pressure is restricted

If you see a stock with massive drop and quick reversal, check if SSR triggered — it often explains the bounce.

Other Rules Worth Knowing

Limit Up / Limit Down (LULD)

Circuit breakers on individual stocks:

If a stock moves too fast in either direction, trading is halted for 5-10 minutes
Prevents flash-crash-style cascades
During the halt, no trading; resumes with an auction

Market-Wide Circuit Breakers

S&P 500 drop triggers market-wide halts:

Level 1: -7% → 15-minute halt (only before 3:25 PM ET)
Level 2: -13% → 15-minute halt
Level 3: -20% → market closes for the day

Last triggered in March 2020 (COVID crash). Worth knowing they exist.

Trading Halts

Individual stocks can be halted for:

News pending (T1 — earnings, M&A, regulatory)
Volatility (LULD)
Regulatory (T12 — accounting issues, etc.)

When halted, no trading. Reopens with an auction once the news is digested.

Reg NMS (National Market System)

Set of rules ensuring price priority across exchanges. The "NBBO" (National Best Bid/Offer) comes from this regulation. You don't need to know the details — just know that all exchanges are linked and your order should get NBBO or better.

What These Rules Mean for Your Trading

If You Have <$25K (You)

✅ Allowed without restrictions:

Swing trading (hold overnight)
Up to 3 day trades per 5 business days
Long-only positions
Standard order types

❌ Effectively restricted:

Day trading stocks (PDT)
Active short selling (margin issues)
Strategies requiring frequent intraday turnover

If You Have $25K+

✅ All of the above PLUS:

Unlimited day trades
4× intraday buying power
Easier margin access

Universal Rules (Apply Always)

⚠️ Always be aware of:

Wash sales (especially Dec-Jan)
Trading halts on news
LULD circuit breakers
SSR triggers on big drops

A Practical Checklist for Compliance

Before placing trades:

Am I within my PDT limit if account < $25K?
Is this a sell at a loss within 30 days of a buy? (Wash sale risk)
Am I using a margin account or cash account? (GFV risk if cash)
Are there any halts or pending news?
Has SSR been triggered if I'm shorting?

This becomes second nature after a while.

A Note on "Rules vs. Spirit"

Most rules exist for good reasons:

PDT slows down retail blowups
Wash sale prevents fake tax losses
LULD prevents flash crashes
Reg SHO prevents naked short attacks

But all rules have exceptions, gray areas, and ways they affect you unexpectedly. Treat them as guardrails, not games to optimize around. Trying to "beat" PDT by opening multiple accounts is the kind of energy that ends with restrictions and account closures.

Practical Takeaways

PDT is the most relevant rule for your account size. With $9K, you cannot meaningfully day trade stocks. This is why swing trading is right.
Wash sales destroy tax planning if you keep retrading the same names. Be especially careful in November-January.
GFVs in cash accounts can lock you out for 90 days. Use a margin account (without using margin).
Halts and SSR are facts of life. Know they exist; don't trade around them blindly.
Trade journaling helps with compliance. A log of when you bought/sold each name lets you check wash sale and PDT counts automatically.

Quick Self-Check

Before moving to 1.11, you should be able to answer:

What is the Pattern Day Trader rule and what's the $25K threshold?
What counts as a "day trade"?
What is the wash sale rule and what triggers it?
What happens to a disallowed wash sale loss?
How can wash sales destroy year-end tax planning?
What is LULD and when does it trigger?
What's the difference between a halt and a market closure?

Previous: 1.9 Margin and Leverage Next: 1.11 Tax Basics for Traders