Day trading patterns involve buying and selling financial assets on the same day to make small profits on a large number of trades. Trend following, range trading, contrarian investing, and scalping are common patterns used by day traders. Pattern day traders must follow certain rules and keep at least $25,000 in a margin account.
Day trading patterns are techniques used by investors who make day trades. This is the action of buying and selling a stock or other financial asset on the same day. The techniques usually involve aiming to make small profits on a large number of trades. To varying degrees, the techniques involve traditional attempts to predict price movements and attempts to exploit the way markets respond to investor behavior.
Arguably the simplest day trading pattern is trend following. This works on the simple basis that if the price of an asset has moved in a certain direction on a consistent basis, it will continue to do so. In day trading, the investor will quickly buy and then sell the asset; Although the potential return is small, the risk is also restricted. It is possible to use trend following on a falling stock by shorting, a technique that involves borrowing a stock, selling it, and then buying it back at a lower price before paying it back. The main limitation of trend following is that it can be difficult to earn a sufficient return to cover transaction costs.
There are two-day trading patterns that work on similar principles to trend following, but assume different market behavior. Range trading works on the idea that a stock will naturally fluctuate between two levels as the market automatically adjusts to its price change. Therefore, the trader tries to buy or sell the stock at the moment its momentum changes. Contrarian investing is based on the idea that a rising stock will eventually have to fall. Although these two theories have different ideas about the long-term movement of the stock, this difference is generally not relevant given how quickly the trader intends to get rid of the stock.
Scalping is a technique based on the way in which multiple traders make offers to buy and sell shares at any time and that these are signaled through an automated system seen by all other traders. The idea is to make the highest offer to buy a stock at any time, usually for as little as a tenth of a cent, then wait until the stock rises and immediately try to make the lowest offer to sell a share, again for the same amount. The smallest margin possible. In theory, this should guarantee the possibility of completing both the purchase and the sale at the desired price. The profit margin is inherently small, so traders aim to maximize returns by making a lot of such trades, usually for large amounts of stock.
The term of day trading patterns should not be confused with the phrase day trader pattern. This is a legal term used by the Securities and Exchange Commission to describe a trader who meets two conditions: that they make at least four days of margined trading in the space of five business days, and that these day trades represent at least six percent of their total trade during that time. A person who is classified as a pattern day trader must follow certain rules, most notably by keeping at least $25,000 United States Dollars (USD) in a margin account. This is designed to make sure that the trader has enough cash to deal with the trades that go against him. Once someone qualifies as a pattern day trader, he must go three months without making any daily trades to lose this restriction.
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