If you look closely, you will find various types of traders and investors operating in the stock markets. Depending on your capital, time horizon, and risk appetite, you can pick up whichever style suits you. But, for the sake of classification, the regulators categorize pattern day trading separately.
As you can understand from the name, traders who regularly execute high-value trades in a pattern are categorized as pattern-day traders. This blog aims to help you learn about pattern day trading and how you can benefit from it in detail.
Initially, you should start by understanding the definition of pattern day trading. To put it simply, a pattern day trader identifies and capitalizes on multiple trend patterns. Their aim is to execute multiple trades and maximize the benefits from potential price movements.
Here’s a breakdown of the characteristics of each component of pattern day trading. It will help you identify whether a trader can be classified as a pattern day trader or not:
If you meet these criteria, your trading account will be flagged as a Pattern Day Trader (PDT) by your stock broker.
Also Read: Day Trading vs Long-Term Investing: Pros, Cons, and Key Differences
If you are an active pattern day trader, it is essential for you to learn about the pattern day trading rules. This will help you avoid pitfalls and regulatory violations. But why is there such high scrutiny on pattern day traders? Here are the reasons:
It is possible that you end up making pattern day trading violations if you are not aware of the rules. Here are the rules you should follow as a pattern day trader:
To make it simpler for you to understand how it works, let’s take a pattern day trading example. Remember, in a day trade, the trader buys and sells the same security within a business day. In this example, a trader is targeting the stock of Company A. See how you can identify pattern day trading from the following data.
Days | Bought | Sold | Number of Day Trades | Percentage (No. of Day Trades ÷ Total No. of Trades) |
Monday | 100 | 100 | 2 | 12.5% |
Tuesday | 200 | 200 | 4 | 25% |
Wednesday | 300 | 300 | 6 | 37.5% |
Thursday | 150 | 150 | 3 | 18.75% |
Friday | 50 | 50 | 1 | 6.25% |
Total Number of Trades during these 5 days | 16 | All trades qualify as pattern- day trading |
You can clearly see how these trades fit the definition of pattern day trading.
By now, you must be curious why traders opt for pattern day trading. Are there any drawbacks to using this aggressive trading strategy? Let’s have a look:
So, we come to the section of key tips you can follow to start pattern day trading. Here are the steps you can take to avoid the pitfalls and become successful:
Also Read: Algo Trading: Transforming Trading into Automation
Strategies like pattern day trading are fast-paced and exciting. However, the stakes in such trades are very high. Not just this, there are several rules and regulations you have to follow while indulging in pattern day trading. By understanding the meaning of pattern day trading and how you can implement this strategy, you can become a successful trader.
Pattern day trading restrictions are put in place to ensure that small retail traders do not take extraordinary risks and lose their hard-earned savings.
As there are high stakes and fast-paced decision-making involved, pattern day trading is highly risky. If you put a single foot wrong, you can end up losing a lot of money.
Pattern day trading violations do attract penalties and restrictions but it is not illegal. To ensure that markets are not destabilized and traders act responsibly, these restrictions are placed on pattern day trading.
The reset period for pattern day trading is 5 days. After completion of these 5 consecutive trading sessions, your trading activity is recalculated.
Yes. Pattern day trading also applies to options. Traders use margin accounts to increase their purchasing power in the options markets. But, they also have to adhere to the same set of rules and regulations there also.