Can I Day Trade With a Cash Account?

Day trading, which involves buying and selling financial instruments within the same trading day, aims to profit from small price fluctuations. A cash account, in contrast to a margin account, requires that all securities purchases be paid for in full with available cash.

Day Trading with a Cash Account Explained

Day trading is indeed possible with a cash account, but it operates under a strict principle: all trades must be executed using fully settled funds. This means that if you use money to buy a security, those specific funds cannot be used again for another purchase until the initial transaction has officially settled. The core limitation in a cash account is that funds are effectively “tied up” during the settlement period. You cannot simply buy and sell a stock multiple times a day with the same capital unless you have sufficient additional settled funds to cover each transaction.

This constraint necessitates careful planning and a larger capital base than one might initially assume for frequent trading. For example, if you have $5,000 in your cash account and use it to buy shares, you cannot sell those shares and immediately use the $5,000 (or the proceeds from the sale) to buy another stock on the same day. You would need an additional $5,000 of settled cash to make a new purchase that day.

Understanding Trade Settlement Rules

The concept of “settlement” refers to the process where the exchange of securities for cash is finalized. For most stock and exchange-traded fund (ETF) transactions in the U.S., the standard settlement period is T+1, meaning the transaction settles one business day after the trade date. For example, if you sell shares on Monday, the funds from that sale will not be fully settled and available for new purchases until Tuesday.

Violations can occur when these settlement rules are not adhered to. A “Good Faith Violation” (GFV) happens when you buy a security with unsettled funds and then sell that security before the initial purchase has been fully paid for with settled funds. For instance, if you sell stock A on Monday, and use those unsettled proceeds to buy stock B on Monday, then sell stock B on Tuesday before the funds from stock A’s sale have settled, you incur a GFV.

Another specific type of violation is “Free Riding.” This occurs when you buy securities and then pay for that purchase by using the proceeds from a sale of the same securities, without ever having sufficient settled funds in the account to cover the initial buy. For example, if you buy $1,000 of stock on Monday with $0 settled cash, and then sell that stock on Tuesday for $1,050 to cover the original purchase, a free riding violation has occurred. This practice violates Regulation T.

Consequences of Settlement Violations

If you receive one Free Riding violation within a 12-month period in a cash account, your brokerage firm will typically restrict your account. This restriction means you will only be able to buy securities if you have sufficient settled cash in the account before placing the order. This restriction usually lasts for 90 calendar days.

For Good Faith Violations, the consequences can vary slightly. Often, the first and second violations may result in warnings. However, if you incur three Good Faith Violations within a rolling 12-month period in a cash account, your account will be restricted to settled cash only for 90 days. During this period, you cannot use unsettled proceeds for new purchases. Repeated or severe violations, particularly if they continue after restrictions are imposed, can lead to further account limitations, including potential freezing or even permanent closure by the brokerage firm.

Key Differences from Margin Account Day Trading

A significant difference between day trading in a cash account and a margin account lies in the application of the Pattern Day Trader (PDT) rules. The PDT rules, defined by FINRA (Financial Industry Regulatory Authority), generally apply to margin accounts and require a minimum equity of $25,000 for frequent day trading activity. Specifically, an individual is labeled a Pattern Day Trader if they execute four or more day trades within five business days, provided these trades constitute over six percent of their total trades in a margin account during that period. If a margin account falls below the $25,000 threshold, the account holder is prohibited from day trading until the minimum equity is restored.

Importantly, the PDT rules and the associated $25,000 equity minimum do not apply to cash accounts. This means a trader with a cash account can technically execute an unlimited number of day trades, provided each trade is made with fully settled funds. While this offers freedom from PDT restrictions, it introduces the stringent settlement limitations discussed previously. Cash accounts are therefore subject to Good Faith Violations and Free Riding rules, while margin accounts are subject to PDT rules and margin calls.