Can I Buy a Stock and Sell It the Next Day?

Buying a stock and selling it the next day is a common practice for active traders. While generally permissible, it involves understanding specific regulatory guidelines and financial implications. Navigating these aspects helps investors manage portfolios effectively and avoid unexpected restrictions or tax consequences. This article clarifies the rules and considerations surrounding short-term stock trading.

Understanding Day Trading Rules

A “day trade” is defined as the purchase and sale of the same security within the same trading day. Specific rules apply to frequent day trading activity, established by the Financial Industry Regulatory Authority (FINRA), particularly FINRA Rule 4210, which governs pattern day traders.

An individual is classified as a “pattern day trader” if they execute four or more day trades within any five consecutive business days, provided these trades constitute more than 6% of their total trading activity in a margin account. This designation primarily applies to margin accounts, which allow investors to trade with borrowed funds. To engage in pattern day trading, individuals must maintain a minimum equity of $25,000 in their margin account.

Failing to meet the $25,000 equity requirement as a pattern day trader can lead to significant account restrictions. If the account balance drops below this threshold, the trader will be prohibited from further day trading until the account is restored to the minimum level. Brokerage firms may issue a day-trading margin call, and if not met within a few business days, the account can be restricted to trading only on a cash available basis for 90 days, or even restricted to liquidation only.

Cash accounts offer an alternative to avoid the pattern day trader rule. However, they have limitations, primarily related to the availability of settled funds for new trades. Trading in a cash account requires all securities to be fully paid for before sale, and using unsettled funds for new purchases can lead to violations. Selling a stock the day after buying it technically avoids the “day trade” definition, as it occurs over two separate trading days. This approach bypasses the pattern day trader rule but still involves short-term trading, with considerations for fund settlement and tax implications.

Settlement Periods and Your Account

Understanding how trades settle is important for anyone buying and selling stocks, especially for short-term transactions. Most stock trades operate under a T+1 settlement rule, meaning trades settle one business day after the trade date. This implies that while a transaction executes immediately in your brokerage account, the actual transfer of ownership and funds is completed on the next business day.

This settlement period has implications for cash accounts. Funds from a sale are not immediately available for withdrawal or reinvestment until they settle. Attempting to buy a security with unsettled funds and then selling it before the initial funds have settled can result in a “good faith violation.” This occurs when a trader sells a stock purchased with unsettled funds, effectively using credit not yet materialized in their account.

Another related issue is “free riding,” which occurs when an investor buys securities and sells them before paying for the original purchase in full. Both good faith violations and free riding can lead to account restrictions. If a cash account incurs three good faith violations within a 12-month period, the brokerage firm can restrict the account for 90 days, allowing purchases only with fully settled funds. Similarly, a free riding violation can result in a 90-day freeze on the cash account, where the investor loses the ability to make purchases with unsettled sale proceeds.

Tax Considerations for Short-Term Trading

The duration for which an investment is held directly influences its tax treatment. Profits from selling stocks are categorized as either short-term or long-term capital gains, each subject to different tax rates. Short-term capital gains are profits from assets held for one year or less. These gains are typically taxed at an individual’s ordinary income tax rate, which can be considerably higher than long-term capital gains rates.

Conversely, long-term capital gains arise from assets held for more than one year. These are generally subject to more favorable tax rates, typically 0%, 15%, or 20%, depending on the taxpayer’s income level. The holding period for tax purposes begins the day after the stock’s purchase and concludes on the day of its sale. For example, to qualify for long-term capital gains treatment, a stock bought on January 1st of one year would need to be sold on or after January 2nd of the following year.

Frequent short-term trading also brings the “wash sale rule” into play, as outlined in Internal Revenue Code Section 1091. A wash sale occurs if a taxpayer sells stock or securities at a loss and then acquires substantially identical stock or securities within 30 days before or after the sale date. The consequence of a wash sale is the disallowance of the loss for tax purposes in the year it occurred. This disallowed loss is added to the cost basis of the newly acquired, substantially identical shares, deferring the recognition of the loss to a later date. Accurate record-keeping of all trades, including purchase and sale dates and prices, is important for proper tax reporting and to navigate these rules.