Good Faith Violation: What It Is and How to Avoid It

If you trade stocks in a cash account, you need to understand good faith violations (GFVs). These violations occur when you sell securities bought with unsettled funds before those funds have settled. While the rules may seem technical, violating them repeatedly can result in serious account restrictions.

What Is a Good Faith Violation?

A good faith violation occurs in a cash account when you buy a security with unsettled funds and then sell that security before the funds used to purchase it have settled. In simpler terms, you are using money that has not officially cleared to buy something, then selling it before that money becomes "real" in your account.

The core rule: In a cash account, you must pay for securities in full before selling them. If you buy with unsettled funds and sell before settlement, you have violated the "good faith" expectation that you had the money to cover the purchase.

Understanding Settlement Times

Settlement is the official transfer of securities and funds between parties. Here are the current settlement timeframes:

Stocks and ETFs: T+1 (trade date plus one business day)
Options: T+1 (trade date plus one business day)
Mutual funds: Varies, typically T+1 or T+2
Treasury securities: T+1

The "T" stands for the trade date. So if you sell stock on Monday, those funds settle on Tuesday (assuming no holidays).

How Good Faith Violations Happen

Let us walk through a typical scenario that causes a GFV:

Example: Creating a Good Faith Violation

Monday:

You have $5,000 in settled cash
You buy $5,000 of Stock A
Later Monday, you sell Stock A for $5,200
You now have $5,200 in unsettled funds (settles Tuesday)

Still Monday:

You use that $5,200 to buy Stock B
Later Monday, you sell Stock B for $5,400

Result: Good faith violation. You sold Stock B (bought with unsettled funds from Stock A sale) before those funds settled.

Good Faith Violation vs. Free Riding

These two violations are often confused but are different:

Good faith violation: Selling a security bought with unsettled funds before those funds settle
Free riding: Buying a security, selling it, and paying for the original purchase with the sale proceeds

Free riding is generally considered more serious and can result in immediate account restrictions. Learn more in our free riding violation guide.

Consequences of Good Faith Violations

The consequences escalate with each violation:

First and Second Violations

Warning notification from your broker
Educational materials about settlement rules
No immediate account restrictions

Third Violation

90-day cash-upfront restriction
Must have fully settled funds before placing any buy order
Cannot use any unsettled funds for purchases

Important

The 90-day restriction can severely limit your trading flexibility. You will need to wait for full settlement before making any new purchases, which means you cannot actively trade your full account value.

Rolling 12-Month Period

Good faith violations are tracked over a rolling 12-month period. After 12 months, earlier violations drop off your record. If you receive a 90-day restriction, that specific restriction lasts 90 days, but the violation stays on record for 12 months.

How to Avoid Good Faith Violations

1. Track Your Settled vs. Unsettled Funds

Most brokers display both settled and unsettled cash balances. Always check your settled cash before making trades. Only use the settled amount for purchases you might sell the same day.

2. Wait for Settlement Before Selling

If you buy stock with unsettled funds, simply hold it until the original funds settle. For stocks, this means waiting until the next business day at minimum.

3. Use a Margin Account

Good faith violations only apply to cash accounts. In a margin account, your broker extends credit for settlement purposes, eliminating this issue. However, margin accounts have their own rules, including the Pattern Day Trader rule.

4. Trade in Separate Pools

Mentally divide your account into "settled" and "unsettled" pools. Only day trade with settled funds. Use unsettled funds only for positions you plan to hold for at least two days.

5. Keep Cash Reserve

Maintain a buffer of settled cash in your account. This gives you flexibility to trade without constantly worrying about settlement timing.

Example: Avoiding the Violation

Correct approach:

Account has $10,000 total: $5,000 settled, $5,000 unsettled
For same-day trades, only use the $5,000 in settled funds
If you buy $3,000 of stock with settled funds and sell same day, you have $2,000 settled + $3,000 unsettled
Your next same-day trade can only use the $2,000 in settled funds

Special Considerations for Active Traders

Multiple Trades Per Day

Active traders in cash accounts need to be especially careful. Each trade creates unsettled funds, and those funds cannot be used for same-day round trips without risking a GFV.

Options Trading

Options also settle T+1, and the same GFV rules apply. If you buy options with unsettled funds and close the position same day before settlement, you commit a GFV.

Partial Positions

GFVs can be partial. If you buy 100 shares using $3,000 settled and $2,000 unsettled, only the portion bought with unsettled funds ($2,000 worth, about 40 shares) would cause a violation if sold before settlement.

What to Do If You Get a Violation

Review your activity: Understand exactly what caused the violation
Contact your broker: Some brokers offer one-time courtesy removals for first violations
Adjust your trading: Modify your approach to prevent future violations
Consider a margin account: If violations are frequent, margin might be more suitable
Track your violations: Know how many you have had in the past 12 months

How Brokers Handle Good Faith Violations

Different brokers have slightly different policies:

Fidelity: Sends warnings, restricts after third violation
Schwab: Similar three-strike policy with 90-day restriction
TD Ameritrade: Tracks violations, restricts repeat offenders
Robinhood: Provides warnings and may restrict day trading in cash accounts

Always check your specific broker's policies, as they can vary in their enforcement and any courtesy removal options.

Track Your Trading Activity

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Summary

Good faith violations occur when you sell securities purchased with unsettled funds before those funds settle. In cash accounts, this is a serious compliance issue that can result in a 90-day trading restriction after three violations within 12 months. To avoid GFVs, track your settled versus unsettled funds carefully, avoid same-day round trips with unsettled money, and consider using a margin account if you need more trading flexibility.

Understanding settlement rules is essential for cash account traders. By being mindful of which funds are settled, you can trade actively without risking account restrictions.