What Is the 3-Day Rule in Stock Trading? (Stocks 3-Day Rule) (2024)

Summary:

The three-day rule in stocks mandates that buyers and sellers in stock transactions fully settle their business within three days of executing a trade. A buyer must send payment to the brokerage firm involved in a trade within three business days of making a purchase. And a seller must deliver stock certificates to the broker in the same time frame. This rule helps keep the stock market stable and minimize stock manipulation. Violation of this rule can result in restrictions being placed on the offender’s account.

There are many rules of the stock market, both official and unofficial. One of the official rules of trading stocks is the three-day settlement rule. This rule is also referred to as the three-day trading rule, or T+3 (which means

trade date plus three days). The three-day trading rule, created by the United States Security and Exchange Commission (SEC), is probably one of the most important rules anyone active in the stock market should know.

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What is the three-day settlement rule?

One term you need to be familiar with to understand this rule is the word “settlement.” In the stock market, settlement is the transfer of securities from the seller to the buyer, and of payment for those securities from the buyer to the seller.

The three-day settlement rule states that a buyer, after purchasing a stock, must send payment to the brokerage firm within three business days after the trade date. The rule also requires the seller to provide the stocks within that time.

So, for example, if you bought stock from Business B, you have up to three business days to transfer money to Business B’s brokerage firm. In turn, Business B has up to three business days within which to transfer the stocks you’ve just purchased into your brokerage account.

Stock transactions are not instantaneous

No matter what it seems like when you buy and sell stocks in your online brokerage account, you don’t actually own a stock you purchase the same day your transaction shows as “filled.” In general, it will take three business days for a settlement to be reached. This can matter for things like dividends, for example, since you need to be an owner of record by a certain date to qualify for a scheduled dividend distribution.

Stock transactions take time because funds need to be properly cleared, and both the buyer and seller need to get appropriate documents together. Or, more often these days, their respective brokerages need to do so by punching the right buttons and getting the right confirmation messages.

So, if you buy or trade stocks on Monday, you’ll receive them, or the money for them in the case of a sale, by Thursday. If you purchase stocks on Friday, you should receive the settlement by the end of the business day on Wednesday. Those involved in finalizing your transaction will spend the days before the settlement is reached getting together documentation and making sure the money is good to go.

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The rule applies to all securities, not just stocks

Keep in mind that while the three-day rule is usually associated with stocks, and while stocks are the focus of this article, the same rule applies to all traded securities, as well, including mutual funds and bonds.

Why this rule is important

This rule was created by the U.S. Securities and Exchange Commission (SEC) in 1993. Before the change, buyers had five business days to settle a transaction. The SEC created T+3 to help prevent sizable losses and strengthen the financial market during times of stress.

The SEC intended the rule to limit the manipulation of stocks, keep a stable market, minimize the risk of financial complications, and make it easier for buyers to pay off their own purchases.

Arguably the most important reason the three-day rule is in place is to help keep a stable market. Having a limited amount of time to settle prevents financial complications such as defaults. If buyers had an unlimited amount of time to pay off their trades, they could end up spending more than they actually have. This is especially prevalent in plunging markets.

If this rule were not in place and a settlement took a long time, individuals could run out of money they initially had, or stock prices could change significantly while parties were still awaiting settlement and could not do any new transactions with the stocks or cash involved.

Violation of the three-day settlement rule

Violation of this rule could result in cash liquidation, free-riding violations, good-faith penalties, or certain restrictions being placed on the offender’s brokerage account.

But how is this rule violated? To understand this, you should be familiar with the term “unsettled cash.” This refers to the proceeds you are entitled to because of a sale that has not been settled yet. Though this cash is not yet in your brokerage account, brokerages will allow you to trade with it as though it were.

You can buy stocks with unsettled cash, but you cannot sell a stock for which your purchase has not settled, particularly a stock purchased with funds that had yet to settle when you made the buy. Doing so will result in a good-faith violation.

Example 1: Brian’s quick cash on Company X

Brian purchases stock from Company X on Tuesday. The purchase has not settled yet, but later that day the stocks for Company X begin to climb, so he decides to sell. Because this transaction involves sale of stocks that haven’t settled, this is a good-faith violation.

Buying and selling the same stocks over the course of the day is called day trading, or pattern day trading. A day trade is when you purchase and sell a stock on the same trading day. While day trading can be done legally, there are specific rules you must follow. If you’re interested in trading stocks professionally, the IRS has specific requirements you must comply with. Rapidly buying and selling shares requires investors to have a pattern day trader account. The most important pattern day trader rule is to be registered with the IRS, and the day trading account must have a minimum equity of $25,000.

Example 2: Hailey’s big gain on Business B

Another form of violation is if someone uses unsettled funds to purchase a stock then sells that stock. Here’s an example:

Hailey has no cash available for trading, so she sells a stock for Company X on Monday and should receive a settlement of $20,000 within three business days. But before she receives that $20,000, she purchases stock from Business B, since her brokerage allows her to trade with unsettled funds. As long as she then waits out the settlement of both her sale of Company X stock and purchase of Business B stock, no problem.

If she turns around and and tries to sell Business B stock for a quick profit, however, this is a violation, as she did not physically have the funds to purchase stock from Business B when she did so. She therefore sold a stock she never genuinely owned. You might be thinking this sounds like a neat trick and great way to earn money as a trader, but it’s actually a violation.

A Good Faith Violation occurs when a Type 1 (Cash) security is sold prior to settlement without having settled funds in the account to pay for the purchase. A purchase is only considered paid for if settled funds are used.” — Fidelity

You’ll hear from your broker

You’ll know if you commit this violation when you receive a secure message warning you. If you commit three good-faith violations in one month, you will only be able to trade stock with settled money.

What about free riding?

Free riding is another violation made possible by the time gap between trade execution and trade settlement. If the net effect of your buying and selling is that the cost of stocks you purchased was paid for with the money earned from selling those same stocks, you’ve committed a free-ride violation. Free riding violates the Federal Reserve Board’s Regulation T, which governs brokers’ provision of credit to customers.

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FAQ

Why do stocks take 3 days to settle?

Sellers are allowed three days to settle so that they can get together appropriate documentation and clear the funds that are to be used.

Why do you have to wait 3 days after selling stock?

The three-day wait is to ensure that the funds have been transferred to the appropriate brokerage firms. The three-day rule sets a maximum rather than minimum, so faster settlement is not impossible. Brokerages prefer to err on the side of safety, however, claiming the full three days they’re entitled to.

How many days after you sell a stock can you buy it back?

If you want to claim a loss on your initial sale for tax purposes, you need to wait 30 days to buy back the same stock. If that isn’t a concern, you may repurchase a sold stock as soon as you have funds available to do so.

How soon can I sell a stock after buying it?

You can sell a stock as soon as your purchase of it has settled.

Key takeaways

  • A “settlement” in stocks is when the money from the buyer has been transferred to the seller, and the stock from the seller has been transferred to the buyer.
  • The three-day settlement rule states that a buyer must settle a transaction within three business days after the purchase date. It also requires sellers to settle their side of transactions within the same time frame.
  • This rule was created by the SEC to help keep the stock market stable and prevent manipulation.
  • Violation of this rule can result in restrictions being placed on the account of the offender.

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If you’re already in the world of investing but are wanting to diversify your approach, check out some alternative investment platforms. These companies’ platforms allow users to invest their money and earn returns. SuperMoney compares these platforms’ ARRs (accounting rate of returns), investment limits, fees, customer reviews, and more, making it easier for you to find the one that best suits your preferences and investment goals.

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Camilla Smoot

Camilla has a background in journalism and business communications. She specializes in writing complex information in understandable ways. She has written on a variety of topics including money, science, personal finance, politics, and more. Her work has been published in the HuffPost, KSL.com, Deseret News, and more.

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What Is the 3-Day Rule in Stock Trading? (Stocks 3-Day Rule) (2024)

FAQs

What Is the 3-Day Rule in Stock Trading? (Stocks 3-Day Rule)? ›

Stocks can be bought and sold within 3 days. However, it is crucial to ensure that the purchase price is fully paid before selling the stock. Selling the stock before full payment can result in a free-riding violation, which leads to a 90-day account freeze.

What is the 3-day rule for stocks? ›

The 3-Day Rule in stock trading refers to the settlement rule that requires the finalization of a transaction within three business days after the trade date. This rule impacts how payments and orders are processed, requiring traders to have funds or credit in their accounts to cover purchases by the settlement date.

What is the 3-day trade rule? ›

Essentially, if you have a $5,000 account, you can only make three-day trades in any rolling five-day period. Once your account value is above $25,000, the restriction no longer applies to you. You usually don't have to worry about violating this rule by mistake because your broker will notify you.

What is the 3 rule in trading? ›

The 3% rule states that you should never risk more than 3% of your whole trading capital on a single deal. In order to safeguard themselves against big losses, traders attempt to restrict exposures on a single deal.

What is the three-day settlement rule? ›

Under the T+3 regulation, if you sold shares of stock Monday, the transaction would settle Thursday. The three-day settlement period made sense when cash, checks, and physical stock certificates still were exchanged through the U.S. postal system.

How do you avoid the 3 day trade rule? ›

The simplest way to avoid being labeled a PDT is to refrain from making more than three day trades within five rolling business days. Additionally, keep the following in mind: Individual options contracts aren't necessarily considered day trades if they're part of a spread or larger order.

What happens if I do more than 3 day trades? ›

If you execute four or more round trips within five business days, you will be flagged as a pattern day trader. Here's where you might be dinged: If you're flagged as a pattern day trader and you have less than $25,000 in your account, you could be restricted from opening new positions.

Can I buy and sell the same stock multiple times in a day? ›

Just as how long you have to wait to sell a stock after buying it, there is no legal limit on the number of times you can buy and sell the same stock in one day. Again, though, your broker may impose restrictions based on your account type, available capital, and regulatory rules regarding 'Pattern Day Traders'.

How often are you allowed to day trade? ›

Understanding the rule

Your account will be flagged for pattern day trading if you make 4 or more day trades within 5 trading days, and the number of day trades represents more than 6% of your total trades in that same 5 trading day period. This rule only applies to margin accounts and IRA limited margin accounts.

Can I day trade with $1000 dollars? ›

Believe it or not, you can start forex day trading with $1,000 or even less. It requires mastering position sizing and managing risks, but if you navigate your way to success, the rewards can be significant. In this article, we will discuss in detail how you can day trade with $1000.

What is No 1 rule of trading? ›

Rule 1: Always Use a Trading Plan

You need a trading plan because it can assist you with making coherent trading decisions and define the boundaries of your optimal trade. A decent trading plan will assist you with avoiding making passionate decisions without giving it much thought.

What is the golden rule of traders? ›

Let profits run and cut losses short Stop losses should never be moved away from the market. Be disciplined with yourself, when your stop loss level is touched, get out. If a trade is proving profitable, don't be afraid to track the market.

What is the 1 2 3 trading method? ›

The classical approach to pattern 1-2-3 involves opening short positions at the break of the correctional low. The buyers who seriously expect the upward trend to be restored are most likely to have set their stop orders there. Their avalanche triggering allows you to see a sharp downward movement in the chart.

What is the 3 5 7 rule in stocks? ›

The strategy is very simple: count how many days, hours, or bars a run-up or a sell-off has transpired. Then on the third, fifth, or seventh bar, look for a bounce in the opposite direction. Too easy? Perhaps, but it's uncanny how often it happens.

How long does it take to sell stock and get money? ›

In fact, it takes two trading days for equity trades to settle. This means if you sold a stock on Monday, you wouldn't receive the cash until Wednesday.

What are the new stock settlement rules? ›

Effective May 28, 2024, the Securities and Exchange Commission will move from the current T+2 settlement (transaction date plus two business days) to a T+1 settlement (transaction date plus one business day). This change shortens the cycle by one day for all U.S. securities transactions.

Why do I have to wait 3 days to sell stock? ›

The three-day settlement rule

The Securities and Exchange Commission (SEC) requires trades to be settled within a three-business day time period, also known as T+3. When you buy stocks, the brokerage firm must receive your payment no later than three business days after the trade is executed.

Can I buy and sell the same stock 3 times a day? ›

As a retail investor, you can't buy and sell the same stock more than four times within a five-business-day period. Anyone who exceeds this violates the pattern day trader rule, which is reserved for individuals who are classified by their brokers are day traders and can be restricted from conducting any trades.

Do I have to wait 3 days to sell a stock? ›

How Long Do You Have to Wait to Sell a Stock After Buying it? Technically, there is no waiting period. You can sell a stock seconds after buying it. However, frequent day trading might classify you as a 'Pattern Day Trader' by the Financial Industry Regulatory Authority (FINRA), which carries certain requirements.

Why am I limited to 3 day trades? ›

You're generally limited to no more than three day trades in a five-trading-day period, unless you have at least $25,000 of equity in your account at the end of the previous day.

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