Pattern Day Trader (PDT) Rules – What is Important to Know

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Day trading is speculation in securitiesspecifically buying and selling financial instruments within the same trading day. Strictly, day trading is trading only within a day, such that all positions are closed before the market closes for the trading day. Many traders may not be so strict or may have day trading as one component of an overall strategy. Traders who participate in day trading are called day traders.

Traders who trade in this capacity with the motive of profit are therefore speculators. The methods of quick trading contrast with the long-term trades underlying buy and hold and value investing strategies. Some of the more commonly day-traded financial instruments are stocksoptionscurrenciesand a host of futures contracts such as equity index futures, interest rate futures, currency futures and commodity futures.

Day trading was once an activity that was exclusive to financial firms and professional speculators. Many day traders are bank or investment firm employees working as specialists in equity investment and fund management.

However, with the advent of electronic trading and margin tradingday trading is available to private individuals. Some day traders use an intra-day technique known as scalping that usually has the trader holding a position for a few minutes or even seconds.

Most day traders exit positions before the market closes to avoid unmanageable risks—negative price gaps between one day's close and the next day's price at the open. Another reason is to maximize day trading buying power. Day traders sometimes borrow money to trade. This is called margin trading. Since margin interests are typically only charged on overnight balances, the trader may pay no fees for the margin benefit, though still running the risk of a margin call.

The margin interest rate is usually based on the broker's call. Because of the nature of financial leverage and the rapid returns that are possible, day trading results can range from extremely profitable to extremely unprofitable, and high-risk profile traders can generate either huge percentage returns or huge percentage losses.

Because of the high profits and losses that day trading makes possible, these traders are sometimes portrayed as " bandits " or " gamblers " by other investors. The common use of buying on margin using borrowed funds amplifies gains and losses, such that substantial losses or gains can occur in a very short period of time.

In addition, brokers usually allow bigger margins for day traders. Because of the high risk of margin use, and of other day trading practices, a day trader will often have to exit a losing position very quickly, in order to prevent a greater, unacceptable loss, or even a disastrous loss, much larger than his or her original investment, or even larger than his or her total assets.

Originally, the most important U. A trader would contact a stockbroker, who would relay the order to a specialist on the floor of the NYSE. These specialists would each make markets in only a handful of stocks.

The specialist would match the purchaser with another broker's seller; write up physical tickets that, once processed, would effectively transfer the stock; and relay the information back to both brokers.

One of the first steps to make day trading of shares potentially profitable was the change in the commission scheme. Inthe United States Securities and Exchange Commission SEC made fixed commission rates illegal, giving rise to discount brokers offering much reduced commission rates.

Financial settlement periods used to be much longer: Before the early s at the London Stock Exchangefor example, stock could be paid for up to 10 working days after it was bought, allowing traders to buy or sell shares at the beginning of a settlement period only to sell or buy them before the end of the period hoping for a rise in price.

This activity was identical to modern day trading, but for the longer duration of the settlement period. But today, to reduce market risk, the settlement period is typically two working days. Reducing the settlement period reduces the likelihood of defaultbut was impossible before the advent of electronic ownership transfer. The systems by which stocks are traded have also evolved, the second half of the twentieth century having seen the advent of electronic communication networks ECNs.

These are essentially large proprietary computer networks on which brokers could list a certain amount of securities to sell at a certain price the asking price or "ask" or offer to buy a certain amount of securities at a certain price the "bid". The first of these was Instinet or "inet"which was founded in as a way for major institutions to bypass the increasingly cumbersome and expensive NYSE, also allowing them to trade during hours when the exchanges were closed.

Early ECNs such as Instinet were very unfriendly to small investors, because they tended to give large institutions better prices than were available to the public. This resulted in a fragmented and sometimes illiquid market. The next important step in facilitating day trading was the founding in of NASDAQ —a virtual stock exchange on which orders were transmitted electronically.

Moving from paper share certificates and written share registers to "dematerialized" shares, computerized trading and registration required not only extensive changes to legislation but also the development of the necessary technology: These developments heralded the appearance of " market makers ": A market maker has an inventory of stocks to buy and sell, and simultaneously offers to buy and sell the same stock.

Obviously, it will offer to sell stock at a higher price than the price at which it offers to buy. This difference is known as the "spread". The market maker is indifferent as to whether the stock goes up or down, it simply tries to constantly buy for less than it sells. A persistent trend in one direction will result in a loss for the market maker, but the strategy is overall positive otherwise they would exit the business. Today there are about firms who participate as market makers on ECNs, each generally making a market in four to forty different stocks.

Another reform made was the " Small Order Execution System ", or "SOES", which required market makers to buy or sell, immediately, small orders up to shares at the market maker's listed bid or ask. In the late s, existing ECNs began to offer their services to small investors.

New brokerage firms which specialized in serving online traders who wanted to trade on the ECNs emerged. Archipelago eventually became a stock exchange and in was purchased by the NYSE.

Moreover, the trader was able in to buy the stock almost instantly and got it at a cheaper price. ECNs are in constant flux. New ones are formed, while existing ones are bought or merged.

As of the end ofthe most important ECNs to the individual trader were:. This combination of factors has made day trading in stocks and stock derivatives such as ETFs possible. The low commission rates allow an individual or small firm to make a large number of trades during a single day.

The liquidity and small spreads provided by ECNs allow an individual to make near-instantaneous trades and to get favorable pricing. The ability for individuals to day trade coincided with the extreme bull market in technological issues from to earlyknown as the Dot-com bubble. In March,this bubble burst, and a large number of less-experienced day traders began to lose money as fast, or faster, than they had made during the buying frenzy.

The NASDAQ crashed from back to ; many of the less-experienced traders went broke, although obviously it was possible to have made a fortune during that time by shorting or playing on volatility. In parallel to stock trading, starting at the end of the s, a number of new Market Maker firms provided foreign exchange and derivative day trading through new electronic trading platforms.

These allowed day traders to have instant access to decentralised markets such as forex and global markets through derivatives such as contracts for difference.

Most of these firms were based in the UK and later in less restrictive jurisdictions, this was in part due to the regulations in the US prohibiting this type of over-the-counter trading.

These firms typically provide trading on margin allowing day traders to take large position with relatively small capital, but with the associated increase in risk. Retail forex trading became a popular way to day trade due to its liquidity and the hour nature of the market. The following are several basic strategies by which day traders attempt to make profits. Besides these, some day traders also use contrarian reverse strategies more commonly seen in algorithmic trading to trade specifically against irrational behavior from day traders using these approaches.

It is important for a trader to remain flexible and adjust their techniques to match changing market conditions. Some of these approaches require shorting stocks instead of buying them: There are several technical problems with short sales—the broker may not have shares to lend in a specific issue, the broker can call for the return of its shares at any time, and some restrictions are imposed in America by the U.

Securities and Exchange Commission on short-selling see uptick rule for details. Some of these restrictions in particular the uptick rule don't apply to trades of stocks that are actually shares of an exchange-traded fund ETF.

Trend followinga strategy used in all trading time-frames, assumes that financial instruments which have been rising steadily will continue to rise, and vice versa with falling. The trend follower buys an instrument which has been rising, or short sells a falling one, in the expectation that the trend will continue.

Contrarian investing is a market timing strategy used in all trading time-frames. It assumes that financial instruments which have been rising steadily will reverse and start to fall, and vice versa. The contrarian trader buys an instrument which has been falling, or short-sells a rising one, in the expectation that the trend will change.

Range trading, or range-bound trading, is a trading style in which stocks are watched that have either been rising off a support price or falling off a resistance price. That is, every time the stock hits a high, it falls back to the low, and vice versa. Such a stock is said to be "trading in a range", which is the opposite of trending. A related approach to range trading is looking for moves outside of an established range, called a breakout price moves up or a breakdown price moves downand assume that once the range has been broken prices will continue in that direction for some time.

Scalping was originally referred to as spread trading. Scalping is a trading style where small price gaps created by the bid-ask spread are exploited by the speculator. It normally involves establishing and liquidating a position quickly, usually within minutes or even seconds. Scalping highly liquid instruments for off-the-floor day traders involves taking quick profits while minimizing risk loss exposure. The basic idea of scalping is to exploit the inefficiency of the market when volatility increases and the trading range expands.

When stock values suddenly rise, they short sell securities that seem overvalued. Rebate trading is an equity trading style that uses ECN rebates as a primary source of profit and revenue. Most ECNs charge commissions to customers who want to have their orders filled immediately at the best prices available, but the ECNs pay commissions to buyers or sellers who "add liquidity" by placing limit orders that create "market-making" in a security.

Rebate traders seek to make money from these rebates and will usually maximize their returns by trading low priced, high volume stocks. This enables them to trade more shares and contribute more liquidity with a set amount of capital, while limiting the risk that they will not be able to exit a position in the stock. The basic strategy of news playing is to buy a stock which has just announced good news, or short sell on bad news. Such events provide enormous volatility in a stock and therefore the greatest chance for quick profits or losses.

Determining whether news is "good" or "bad" must be determined by the price action of the stock, because the market reaction may not match the tone of the news itself. This is because rumors or estimates of the event like those issued by market and industry analysts will already have been circulated before the official release, causing prices to move in anticipation.

The price movement caused by the official news will therefore be determined by how good the news is relative to the market's expectations, not how good it is in absolute terms. Keeping things simple can also be an effective methodology when it comes to trading. These traders rely on a combination of price movement, chart patterns, volume, and other raw market data to gauge whether or not they should take a trade.

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Direct market access DMA is a term used in financial markets to describe electronic trading facilities that give investors wishing to trade in financial instruments a way to interact with the order book of an exchange. Normally, trading on the order book is restricted to broker-dealers and market making firms that are members of the exchange.

Using DMA, investment companies also known as buy side firms and other private traders use the information technology infrastructure of sell side firms such as investment banks and the market access that those firms possess, but control the way a trading transaction is managed themselves rather than passing the order over to the broker's own in-house traders for execution.

Today, DMA is often combined with algorithmic trading giving access to many different trading strategies. Certain forms of DMA, most notably "sponsored access," have raised substantial regulatory concerns because of the possibility of a malfunction by an investor to cause widespread market disruption.

As financial markets moved on from traditional open outcry trading on exchange trading floors towards decentralised electronic, screen-based trading and information technology improved, the opportunity for investors and other buy side traders to trade for themselves rather than handing orders over to brokers for execution began to emerge. The implementation of the FIX protocol gave market participants the ability to route orders electronically to execution desks.

Advances in the technology enabled more detailed instructions to be submitted electronically with the underlying order. The logical conclusion to this, enabling investors to work their own orders directly on the order book without recourse to market makers , was first facilitated by electronic communication networks such as Instinet.

Recognising the threat to their own businesses, investment banks began acquiring these companies e. Most major sell-side brokers now provide DMA services to their clients alongside their traditional 'worked' orders and algorithmic trading solutions giving access to many different trading strategies. There are several motivations for why a trader may choose to use DMA rather than alternative forms of order placement:.

Advanced trading platforms and market gateways are essential to the practice of high-frequency trading. Order flow can be routed directly to the line handler where it undergoes a strict set of Risk Filters before hitting the execution venue s. The race for ultra-low latency direct market access is a hot topic amongst high frequency traders, Brokers and technology vendors such as Artha Financial Technology , Fusion Systems Raptor, Ullink or Fidessa.

One area in which low-latency systems can contribute to best execution is with functionality such as direct strategy access DSA [3] and Smart Order Router. Foreign exchange direct market access FX DMA refers to electronic facilities that match foreign exchange orders from individual investors and buy-side firms with bank market maker prices.

FX DMA infrastructures, provided by independent FX agency desks such as DMALINK , consist of a front-end, API or FIX trading interfaces that disseminate price and available quantity data from multiple bank contributors and enables buy-side traders, both institutions in the interbank market and individuals trading retail forex in a low latency environment.

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