Can You Trade With Unsettled Cash?

Investors often sell existing holdings to reinvest the proceeds. This common practice raises questions about the timing of transactions, particularly when funds from a recent sale have not yet fully cleared. Understanding the rules surrounding “unsettled cash” is important for investors to navigate the market efficiently and avoid trading complications. This article clarifies the guidelines for trading with these funds, helping investors prevent common issues that can arise from mismanaging settlement periods.

Understanding Unsettled Cash

Unsettled cash refers to proceeds from the sale of securities that have not yet completed the formal transfer process. When a security is sold, the transaction is not instantaneous. Instead, there is a period during which ownership transfers to the buyer and funds move to the seller’s account. This delay ensures the orderly exchange of assets between parties and their respective brokerage firms.

This transfer period is known as the settlement period, which varies depending on the type of asset traded. Most stock and bond transactions settle on a T+2 basis, meaning the transaction is finalized two business days after the trade date. Mutual funds and options usually settle on a T+1 basis, with funds clearing one business day post-trade. Regulatory bodies mandate these standardized settlement times to ensure operational efficiency.

It is important to distinguish between when funds are “available to trade” and when they are “available to withdraw.” Brokerage platforms often allow investors to use the proceeds from a sale to initiate a new trade immediately, even if the original sale has not fully settled. However, these same funds cannot be transferred out of the brokerage account for personal use until the settlement process is complete and they are considered fully “settled cash.” This distinction is important for understanding how these funds can be used.

Trading Rules for Cash Accounts

In a standard cash brokerage account, investors are generally permitted to use the proceeds from a security sale to purchase a new security immediately, even if the original sale has not yet fully settled. This flexibility allows for continuous participation in the market without waiting for funds to formally clear. However, a significant caveat exists regarding the subsequent sale of the newly acquired security. The new security purchased with unsettled funds must be held in the account until the proceeds from the initial sale have fully settled.

This requirement is based on the principle of “good faith” trading, where it is expected that trades are backed by fully settled funds. If an investor sells a security and uses those unsettled proceeds to buy another security, and then sells that second security before the first transaction has settled, a good faith violation can occur. Brokerage firms closely monitor these activities to ensure compliance with regulatory standards designed to prevent excessive trading on funds that are not yet officially owned.

To illustrate, consider an investor who sells Stock A on Monday. The proceeds from Stock A are unsettled until Wednesday (T+2). The investor can use these unsettled funds on Monday to purchase Stock B. This transaction is permissible as long as Stock B is held until at least Wednesday, when the original sale of Stock A settles. Conversely, if the investor sells Stock A on Monday, uses the unsettled funds to buy Stock B on Monday, and then sells Stock B on Tuesday (before Stock A settles), this action would likely trigger a good faith violation.

Avoiding Good Faith Violations

A good faith violation (GFV) occurs when an investor purchases a security in a cash account and then sells that security before the funds used for the purchase have fully settled. This means the transaction was not executed using fully cleared and available cash. Brokerage firms closely monitor such violations.

The consequences of good faith violations escalate with repeated occurrences. A first violation typically results in a warning from the brokerage firm. However, accumulating multiple violations within a specific timeframe, commonly three violations within a 12-month period, can lead to more severe restrictions. Under these circumstances, the account may be restricted to “settled cash only” for a period of 90 days, meaning the investor can only buy securities with funds that have already fully cleared. Persistent and severe violations can even result in the brokerage firm closing the account entirely.

To avoid good faith violations, investors should manage their cash balances carefully. Always confirm the settlement date of any previous sales before initiating new purchases, especially if there is an intention to sell the new security quickly. Maintaining a sufficient reserve of fully settled cash in the account can provide the flexibility needed for immediate re-investment without incurring violations. Additionally, investors should utilize the features provided by their brokerage platforms, which often display both “cash available to trade” and “cash available to withdraw,” to understand their settled fund status.

Margin Accounts as an Alternative

For investors seeking greater flexibility with trading proceeds, a margin account presents an alternative to a traditional cash account. Unlike cash accounts, margin accounts allow investors to borrow funds from their brokerage firm to finance securities purchases. This borrowing capacity effectively bypasses the constraints of unsettled cash, as the investor can use borrowed funds to make new trades immediately, even if previous sales have not yet settled.

Opening and maintaining a margin account involves specific requirements, including meeting minimum equity thresholds, typically $2,000 as mandated by FINRA for initial margin. Brokerage firms also assess investor suitability to ensure that the account holder understands the complexities and risks associated with margin trading. The ability to trade on margin provides immediate liquidity, allowing investors to capitalize on market opportunities without waiting for settlement periods to conclude.

However, the use of a margin account introduces additional risks that are not present in cash accounts. Investors incur interest charges on any borrowed funds, which can impact overall returns. Furthermore, margin accounts are subject to margin calls, which occur when the value of the securities held on margin falls below a certain threshold, requiring the investor to deposit additional funds or securities. Borrowing amplifies both gains and losses, meaning an investor can lose more than their initial investment.