Can I Use Unsettled Funds to Buy Stock?
Navigate stock trading with unsettled funds. Learn about settlement rules, potential violations, and best practices for managing your brokerage account.
When trading stock, a common question arises about using funds from a recent sale for a new purchase. Unlike typical retail transactions, stock market trades do not instantly transfer ownership and cash. This delay introduces the concept of “unsettled funds,” which are proceeds from a stock sale that have not yet officially cleared and been credited to a brokerage account. Understanding this settlement period is crucial for investors to navigate trading rules and avoid violations.
Understanding Unsettled Funds
Unsettled funds refer to the money from a securities sale that has not yet completed the formal settlement process. When an investor sells shares, the trade executes immediately, and the proceeds often appear in the account as “cash available for trading.” However, these funds are not yet “settled cash” ready for withdrawal or for subsequent purchases.
The standard settlement period for most stock trades in the United States is T+1, meaning the trade date plus one business day. This T+1 cycle replaced the previous T+2 standard, aiming to reduce market risk and enhance efficiency. This settlement period allows for the official transfer of securities from the seller’s account to the buyer’s account and the corresponding transfer of cash. For example, if shares are sold on a Monday, the funds generally settle by Tuesday.
Brokerage accounts distinguish between “cash available for withdrawal” (fully settled funds) and “cash available for trading” (which may include unsettled proceeds). Brokerage firms facilitate immediate trading with unsettled funds in cash accounts, but this comes with specific conditions to prevent regulatory violations.
Rules for Using Unsettled Funds
The use of unsettled funds to purchase new securities, particularly in cash accounts, is governed by specific regulations to prevent speculative trading with money that has not officially cleared. A primary concern is the “good faith violation” (GFV). A GFV occurs when an investor buys a security using unsettled funds and then sells that newly purchased security before the funds from the initial sale have settled. This means the investor did not allow the original transaction to fully complete before liquidating the subsequent purchase.
Another, more severe, violation is “free-riding,” prohibited by FINRA Rule 4210. Free-riding happens when an investor buys a security and then sells it without ever having the full payment in the account by the settlement date. This often involves using the proceeds from the sale of the same security to cover its initial purchase, effectively trading without putting up one’s own money. For instance, if an investor buys shares, and the deposit intended to cover the purchase fails or bounces, then the investor sells those shares, a free-riding violation is triggered.
Preventing Unsettled Fund Violations
Investors can adopt several practices to avoid triggering unsettled fund violations. The most straightforward approach is to consistently wait for funds to fully settle before using them for new purchases, especially if there is an intention to sell the newly acquired securities soon after. This eliminates the risk of a good faith violation, as the underlying funds would be fully cleared before any subsequent sale.
Brokerage accounts display different balances, such as “cash available for trading” and “settled cash” or “cash available for withdrawal.” Investors should focus on the “settled cash” balance when planning new trades to ensure compliance. Understanding how a brokerage firm presents these balances and its internal policies regarding unsettled funds is important.
Impact of Unsettled Fund Violations
Incurring unsettled fund violations carries direct consequences for an investor’s trading account. For good faith violations, while initial instances might result in warnings, repeated occurrences can lead to a 90-day cash account restriction. This restriction means the investor can only buy securities if they have sufficient settled cash in the account before placing the order, effectively preventing trading with unsettled proceeds.
Free-riding violations result in an immediate and more stringent restriction. A single free-riding violation within a 12-month period can lead to a 90-day restriction where the account is limited to using only settled cash for new trades. In more severe or repeated cases, brokerage firms may impose additional penalties, such as freezing the account or, in extreme situations, closing it entirely. These regulatory actions are designed to enforce compliance with market rules and discourage behaviors that could undermine financial stability.