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What are the Different Types of Day Trading Patterns?

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  • Written By: John Lister
  • Edited By: Kristen Osborne
  • Last Modified Date: 10 November 2016
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Day trading patterns are techniques used by investors who carry out 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 differing degrees, the techniques involve traditional attempts to predict price movements, and attempts to exploit the way in which the markets respond to investor behavior.

Arguably the simplest of the day trading patterns is trend following. This works on the simple basis that if an asset's price has moved in a certain direction consistently, it will continue to do so. In day trading, the investor will buy and then quickly 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 it, a technique that involves borrowing a stock, selling it, then buying it back at a lower price before returning it. The main limitation of trend following is that it can be difficult to make enough of a return to cover transaction costs.

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There are two day trading patterns that work on similar principles to trend following, but assume a 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 changing. The trader thus tries to buy or sell the stock at the point its momentum changes. Contrarian investing works on the idea that a rising stock will eventually have to fall. Though these two theories have different ideas about the long-term movement of the stock, this difference usually isn't relevant given how quickly the trader intends on disposing of the stock.

Scalping is a technique based on the way multiple traders make offers to buy and sell stocks at any instant 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 moment, usually by as little as a tenth of a cent, then to wait until the stock rises and immediately attempt to make the lowest offer to sell a stock, again by the smallest possible margin. In theory, this should guarantee being able to complete both the purchase and sale at the desired price. The profit margin is inherently tiny, so traders aim to maximize returns by making a lot of such trades, usually for high quantities of stocks.

The term day trading patterns should not be confused with the phrase pattern day trader. This is a legal term used by the Securities and Exchange Commission to describe a trader who meets two conditions: that he carries out at least four day trades on margin in the space of five business days, and that these day trades make up at least six percent of his total trading during that time. A person who is classed as a pattern day trader must follow certain rules, most notably keeping at least $25,000 U.S. Dollars (USD) in a margin account. This is designed to make sure the trader has enough cash to cope with trades going against him. Once somebody is classed as a pattern day trader, he must go three months without carrying out any day trades to lose this restriction.

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