When trading stocks or other securities on the same day in a cash account, it is important to understand the rules to avoid possible violations.This includes a Integrity violation.
Before trading on the first day, you need to decide whether you plan to Margin basis or cash account.
Today, we will look at cash accounts and the integrity violations (GFV) that apply to these types of accounts.
What is a cash account?
If you want to buy or sell stocks, the first step is to open an account with a reputable online broker.
Examples of popular US brokerage firms include Lightspeed, Robinhood, Ameritrade, E-Trade, Charles Schwab, TradeStation, Interactive Brokers, to name a few.
Once you have chosen your broker, you have two options: Margin or cash account.
A sort of Margin Account It is a trading account that allows you to borrow money through a broker to buy stocks on margin.
Using a margin account, your purchasing power will be twice that of a cash account, which will give you the opportunity to conduct larger-scale transactions and generate more profits.
A sort of Cash account It’s very simple. With this account, you can only trade with the money you have on hand. Unlike a margin account, you cannot use a cash account to borrow money from a broker.
For example, if you have $1,000, you can only buy stocks worth $1,000, and you cannot use the stock in your cash account as collateral to borrow more funds from your broker.
Although a cash account will not give you enough purchasing power, one of the biggest advantages of using such an account is that you can help prevent huge losses, especially if you are an active trader.
Before we delve into integrity violations, it is important to explain how stocks or other securities are paid. When you buy and sell stocks, your transactions happen immediately.
However, even if your newly purchased stock now appears in your brokerage account, the transaction will not be settled. Market rules allow transactions (settlement) to be treated as formal transactions within a few days.
Settlement date is the date when the transaction is completed and the buyer must pay the seller and the seller transfers the guarantee to the buyer.
For options and government securities, the settlement date is usually the next business day (T+1). Stocks and bonds are two trading days after the execution date (T+2).
What is a breach of integrity?
When you buy a stock and sell it before the funds you used for the purchase are settled, it is a violation of good faith. Only the full payment of the proceeds from the sale of securities or cash is eligible for settlement funds.
The reason that liquidation of a position before the settlement fund is used to pay for the position is called an “integrity violation” because there is no sincere effort to deposit the necessary cash into the account before the settlement date.
What are examples of breaches of integrity?
The following example shows how a hypothetical trader (Jim) might violate integrity.
Suppose Jim has $0 in his cash account.
On Monday morning, he sold shares of Apple (AAPL) and generated cash account proceeds of $5,000. In the late afternoon, Jim bought Tesla (TSLA) stock for $5,000.
If he sells TSLA shares before Wednesday (the settlement date of the AAPL sale), the transaction will be considered a breach of good faith because he sold TSLA shares before the account had sufficient funds to fully satisfy the purchase demand.
Assume that the cash available for trading in Jim’s cash account is $1,000 minus the cash credit for unsettled activities = $500 (Proceeds from the sale of stocks last Friday-trading settlement on Tuesday)
On Monday morning, Jim bought TSLA stock worth $1,500. If he sold the stock later in the day, he would violate integrity.
The purchase of stocks is not considered a full payment, because the proceeds of $500 are not considered sufficient funds before settlement on Tuesday.
Suppose Jim has a settlement cash balance of $2,000. Then he bought TSLA stock for $2,000 on Monday morning.
In the late afternoon, he sold the stock for $2,500. When the market was about to close, Jim bought $5,500 in AAPL stock.
At this time, there was no breach of integrity because he had sufficient funds to purchase TSLA stock. However, if he sells AAPL stock before receiving payment (settlement), then a breach of integrity will occur.
Consequences of breach of integrity
When an integrity violation occurs, your broker will notify you that the violation has occurred and explain the consequences if it occurs twice. The news will also include steps on how to avoid GFV in the future.
If you have three integrity violations in your cash account within 12 months, your broker will limit your account for 90 days.
This means that you can only buy stocks if you have fully settled the cash in your account before making the transaction.
How to avoid violations of integrity
The easiest way to avoid violations of integrity is to ensure that you only buy stocks with fixed capital.
Another good way to avoid any problems is to wait at least two trading days after buying a stock before selling it.
Trading day refers to any day when the New York Stock Exchange (NYSE) and Nasdaq are open for trading.
Although cash accounts are not subject to model day trading rules, they are subject to integrity violations under the jurisdiction of the Federal Reserve Board of the United States Regulation T.
The regulation was originally formulated to manage margin accounts, but later expanded to manage transactions in cash accounts.
Since stock transactions held in a cash account for less than two days require settlement funds to avoid violations of integrity, it is recommended to wait at least two days between transactions to avoid performing short-term transactions or day transactions with unsettled funds.
Limiting intraday transactions to settlement funds can greatly help minimize the risk of integrity violations.