How to Avoid Pattern Day Traders
Day traders are speculators trying to take advantage of price movement during intraday trading on the stock market. Many day traders use programs on computers with sophisticated algorithms that identify patterns to act on. By recognizing the patterns these traders look for, it is possible to avoid some of the risks that exist while executing a trade. These patterns are most readily identified on a chart, and are avoided using built-in strategies offered by your broker.
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Instructions
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Avoiding Abuse from Day Traders
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Chart the historic behavior of your chosen stock. Your online broker should offer a charting service, but Stockcharts.com also offers free effective charting tools. Trading patterns are most easily viewed on a one-year chart. Many day traders use technical analysis to place trades. Technical analysis is the practice of studying historical price behavior to determine future price action. Day traders most often act on what are called "areas of resistance." An area of resistance can be identified on a chart by seeing where the chart line seems to reach a price point and then retract. Bollinger-Bands usually identify these areas of resistance successfully. Bollinger-Bands can be found on your charting service as a technical analysis tool that is superimposed on the chart. The bands show lines that are exactly two standard deviations away from the 20-day moving average of the stock price. These lines are historically effective in showing where resistance exists and exposing patterns often exploited by day traders.
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Use limit orders as opposed to market orders. Market orders are trades placed at the next available price. Market orders require less commission, but are risky. These orders are risky because in the time between you placing an order and the time of its execution, a day trader could place a large order that dramatically changes your trade price. Limit orders eliminate this risk by telling the broker to only place the trade at your price or better. With a limit order, you know the price your trade will be executed at and eliminate risk created by day traders. Limit orders often require more commission, but not excessively so.
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Use stop-loss orders. Stop-loss orders are contingent orders sent to your broker in the event of a dramatic price drop. You select a price at which you want the stock to be sold, and the broker guarantees it is filled at that price. This prevents risk created by programs used by day traders which can dramatically drop the price of a stock. Stop-loss orders require more commission than regular "sell" orders, but not excessively so.
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Tips & Warnings
Studying technical analysis can help you learn more about your competition in the stock market. Technical patterns are used very frequently by day traders, and can also help you make more informed investment decisions.
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