Trade date/Settlement date and SEC restrictions

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stocknoob4111
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Trade date/Settlement date and SEC restrictions

Post by stocknoob4111 » Fri Jan 12, 2018 9:18 pm

Trying to understand this more clearly but have a few questions. From what i've read you sell a security and it settles in 2-3 days. The brokerage indicates the settlement date. What is the "free riding" SEC restriction here? From what I am guaging it means that you can't buy a security and then sell it again before the transaction settles? In this case how do investors buy and sell on the same day? Say buy in the morning at $10 and sell those same shares in a few hours if it has gone up to say $12. Looking at SEC rules this is prohibited? Or am I missing something?

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grabiner
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Re: Trade date/Settlement date and SEC restrictions

Post by grabiner » Fri Jan 12, 2018 9:47 pm

Freeriding, and related violations, occur when you buy and sell stock without having the funds to pay for the purchase. Effectively, you are getting credit from your broker, which is not allowed in a cash account. (You can have a margin account in which your broker does give you credit.)

The 2-day settlement rule allows you to sell and buy on the same day, or buy and sell, but not sell, buy, and sell.

Sell and buy: You have no cash in your account. On Tuesday, you sell $1000 worth of stock, and buy $1000 worth of another stock. On Thursday, you receive the cash from your sale, and you have the cash available to pay for your purchase, so this is allowed. (This is a very common trading situation.)

Buy and sell: You have $1000 of cash in your account. On Tuesday morning, you buy $1000 worth of stock, and on Tuesday afternoon, you sell the same stock for $1200. You already had the cash on hand to pay for the purchase, so this is allowed.

Sell, buy, and sell: You have no cash in your account. On Tuesday morning, you sell $1000 worth of stock, and buy $1000 worth of another stock. On Tuesday afternoon, you sell the stock you bought on Tuesday morning. This is not allowed; you did not have any cash to pay for the stock you bought, and you sold it first. (For example, if the morning sale didn't go through because the seller didn't deliver the stock, you might have to return the morning purchase because you didn't have the funds, but you can't return the purchase because you no longer have it.)
David Grabiner

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Re: Trade date/Settlement date and SEC restrictions

Post by 123 » Fri Jan 12, 2018 9:49 pm

If your brokerage account has margin privileges (and you keep your trades within your margin limits) then you can do a lot of stuff without any issues. (Margin isn't available on retirement/tax deferred accounts).

SEC regulations prohibit a "free ride", when you purchase securities with unsettled funds. If you buy and sell a stock before paying for it you are free riding. If you've always got enough cash in your account to cover your purchases it really isn't an issue.
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ResearchMed
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Re: Trade date/Settlement date and SEC restrictions

Post by ResearchMed » Fri Jan 12, 2018 9:54 pm

stocknoob4111 wrote:
Fri Jan 12, 2018 9:18 pm
Trying to understand this more clearly but have a few questions. From what i've read you sell a security and it settles in 2-3 days. The brokerage indicates the settlement date. What is the "free riding" SEC restriction here? From what I am guaging it means that you can't buy a security and then sell it again before the transaction settles? In this case how do investors buy and sell on the same day? Say buy in the morning at $10 and sell those same shares in a few hours if it has gone up to say $12. Looking at SEC rules this is prohibited? Or am I missing something?
If you are using "different money" for the sell and buy orders, then there isn't a problem.
The potential problem exists if you are using the proceeds from the sell order to fund the buy order.
If you've got enough cash (or a margin account, I think), then this isn't an issue.

RM
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