Within a brokerage account, securities transactions are segregated by type for regulatory and accounting purposes. Prior to placing an order in a cash account, the client is expected to deposit enough funds to pay for the transaction in full.
If a position is purchased and sold in a cash account without being fully paid for, Regulation T of the Federal Reserve Board requires the account to be restricted for 90 Days. You will not be able to place trades on the Internet for 90 days. You will have to phone your orders in. You will be prohibited from creating a "margin call" in your account.
Note: If the security is bought and sold with out being fully paid for, but the money is received by the buy-side settlement date, the restriction can be lifted.
In a Cash account on 90-day restriction, once a security is sold, the proceeds of the sale may not used to buy any security until settlement date. (Settlement date is 3 business days for stocks.) Accounts placed on 90-day restriction will be forced to place orders via telephone and will be charged a commission at the Internet rate plus an extra $10. Day-trading with unsettled funds and debit balances are prohibited in cash accounts.
The disadvantages of having a cash account only are:
You must have all the cash in your account prior to entering an order. A cash account will be put on 90-Day Restriction, if a security is bought and sold without being fully paid for. Accounts placed on 90-Day restriction will be charged a $19.95 equity commission rate by Trading Direct. No trading will be allowed via the Internet if you are placed on 90-day restriction, however you will be able to view activity, balances, positions, etc.
Once you sell a stock in your cash account, technically you are supposed to wait 3 business days for settlement before the money may be used to buy something else, but if the new stock that you buy is not sold before the previous sale settles, you will be ok.
Here is an example of using unsettled funds in your cash account, which would cause a good faith violation to be issued:
If you sell a particular stock today, you are not suppossed to buy the same stock back the same day using the proceeds from the previous sale. Here is example of an intra-day cash trade of the same stock, which would cause a good faith violation to be issued:
Note: If you buy and sell a stock with unsettled funds, you will be issued a "good-faith violation". This will remain notated in your account for 15 months. After 4 good-faith violations in a 15 month period, your account will become restricted.
A margin account must be used in order to borrow funds and or day trade. Active traders should place their orders in a margin account to avoid potential restrictions associated with cash account trading. To obtain margin trading privileges, you must have a signed margin agreement on file and have $2000 minimum equity in cash or marginable securities. Not all securities are marginable. Generally stocks priced over $3 per share on the New York Stock Exchange (NYSE), American Stock Exchange (AMEX), and NASDAQ National Market (NNM) may be marginable. Mutual Funds are not marginable for the first 30 days. In general, the initial margin requirement for a long position is 50%. The minimum maintenance requirement is 30% in a non-concentrated account. Maintenance for a concentrated account is 50%. A concentrated account is defined as an account with one position equal to or greater than 60% of the total market value.
Effective August 2001, updated rules concering day-trading were issued by the New York Stock Exchange (NYSE). In general, if your account is under $25,000 in marginable equity, you must not execute more than 3 margin day-trades in a five business day period. (Marginable equity may consist of cash, or stocks which are over $3 per share and trade on the NYSE, American Stock Exchange, or Nasdaq National Market.) If you execute 4 day-trades in a 5 business day period, your account will be coded as that of a "pattern day-trader", and will be subject to a $25,000 minimum balance in order to engage in future margin trading.
A short sale is the sale of securities not owned by the customer. A short seller sells securities at a higher price, in anticipation of a market decline. Once the price of the position falls, the securities are bought back at a lower price. The short seller profits from the decline. The actual shares are borrowed from the broker and sold in the open market. The shares are returned when the customer buys back the stock. Closing a short position is called "buying to cover short." Not all stocks may be borrowed and shorted. The shares must be available to be borrowed and the stock must be marginable, but atleast $5 per share must be put up for margin. Generally, stocks priced over $3 on the NYSE, AMEX, and NNM are marginable.