What Is a Pattern Day Trader?
A pattern day trader is someone who makes many rapid buy and sell transactions in the stock market in the same trading day, hoping to make small but consistent profits. The U.S. Securities and Exchange Commission defines someone as a pattern day trader if they make four or more intraday transactions in the same stock over a five-day period.
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History
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Independent day trading dates back to the late 1990s, when vast increases in personal computing power and improvements in communications technology gave traders access to unprecedented amounts of data and allowed them to make buy and sell decisions in a fraction of the time it used to take. The rise of discount brokerages also made rapid-fire trading affordable, in contrast to the large commissions charged by full-service brokers.
Capital Requirements
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As per the rules of the New York Stock Exchange and Financial Industry Regulatory Authority, a pattern day trader must have at least $25,000 in their brokerage accounts at all times, and must place their trades within a margin account.
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Strategies
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Pattern day traders usually pursue a high-frequency trading strategy, seeking to profit from small fluctuations in several stocks throughout the same day, as opposed to buying and holding for weeks or months. Day traders typically make transactions in big name, extremely liquid stocks, which have high volume and tight bid/ask spreads to allow them to rapidly enter and exit positions within seconds. (The bid/ask spread is the difference between the highest price buyers are willing to bid and the lowest price sellers are willing to ask.)
Margin
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All pattern day traders trade in margin accounts, but not all of them necessarily borrow capital from their brokers. Those that do borrow can sometimes borrow up to four times the cash value of their accounts, allowing them to dramatically expand their buying power and profit potential, but this also greatly expands their risk.
Misconceptions
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In the general media, almost any individual who trades or invests full-time is considered a day trader. In proper use, this term should only be applied to traders who employ high-frequency strategies, making dozens to hundreds of trades in a single day.
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References
- Photo Credit Image by Flickr.com, courtesy of Perpetual Tourist
