Pattern day trading explained
Many traders repeatedly buy and sell assets that could offer same-day profits. These individuals are called pattern day traders (PDTs). Here, we explore the basics of pattern day trading and summarise what it means to be a PDT.
What is a pattern day trader?
A pattern day trader (PDT) is a trader who buys and sells the same financial market, such as forex or shares, on the same day, on the same margin trading account. To be considered a PDT, you must execute more than four day trades on your account in a five-day period.
If you execute fewer than four day trades in five days, then you’re still a day trader – just not a PDT. These trades must also comprise more than 6% of the total trades on your account.
Pattern day trading basics
To be a pattern day trader, you have to trade using a margin account. With this type of account, you trade using leverage. This means you can open a position with a deposit and still get exposure to the full value of the trade. Trading on margin will magnify your profits, but it will also amplify any losses.
Pattern day trading can be a time-intensive activity, which means you’ll have to check market prices and news regularly. You should rely on thorough technical analysis to help you identify signals to open and close trades. You can also use fundamental analysis to prepare for upcoming economic events that may cause volatility in the market.
The pattern day trader rule
The pattern day trader rule is a regulation set by the Financial Industry Regulatory Authority (FINRA), a trading governing body in the US, ‘to discourage people from trading excessively’. The rule requires traders to have at least $25,000 in their margin trading accounts on any given day, in order to reduce their risk.
If your trading broker is not regulated by FINRA – ie it is regulated by an authority outside of the US – you will not be bound by the pattern day trader rule.
Pattern day trading example
Let’s say you thought that Apple shares (AAPL) were about to increase in value, so you decide to go long on 50 shares at $310. Before the end of the trading day, you close your position when shares reach $325. The next day, you go short at a price of $321 and close a few hours later at $330. On the third trading day, you go long again at $322 a share and close at $332 before the end of the trading day.
You’re making a profit, so you continue this behaviour for five days, opening and closing long and short trades, on the same trading period, on the same margin trading account. In doing so, you become a pattern day trader.
Remember, if you held your positions overnight instead of closing them the same day, you would not be considered a pattern day trader.
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