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Investing 101: Good Faith Violation               


In my continued quest to keep investors investing like a pro, I would like to make you aware of a third trading violation, and that is the Good Faith Violation.

A Good Faith Violation occurs when an investor buys a security (stocks, bonds, etc.) and sells it before the initial purchase is able to settle with sufficient funds.  If this sounds slightly confusing, let me offer this analogy: A good faith violation is similar to you eating $100 worth of food at a restaurant, receiving the $100 bill but having less than $100 on your person to pay for the food when it comes time to “settle up” on your bill.  Then, you have to wait a few minutes, or hours, before someone brings you the funds necessary to cover the $100 restaurant bill. 

But, a more applicable, and higher-fidelity, example of a Good Faith Violation would be as follows:

On January 1, your account is as follows:
Cash on hand: $1,000.00
You initiate the purchase of 100 shares of ABCD stock at $10 per share for a total of $1,000.

On January 2:
Cash on hand: $0.00
You initiate the purchase of 50 shares of WXYZ stock at $30 per share for a total of $1,500.
You initiate the sale of 100 shares of ABCD stock at $15 per share for a total gain of $1,500.

This may seem like it is a “wash”, or break even, but it actually may not be.  You initially used up all of your funds to purchase ABCD stock.  And, even though you are going to have $1,500 of cash coming back into your account due to the sale of ABCD stock, your initiation of the purchase of WXYZ stock may go to settlement before your sale of ABCD can replenish your account.  And, if this occurs, you would have violated the Good Faith Violation rule.

Violation of such rules may lead to restrictions on your brokerage account.  Always check with your broker for detailed information on brokerage rules and regulations and consult with your broker for extensive information on the Good Faith Violation rule.




 
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