When you get introduced to the world of Day trading, you often see multiple trades taking place on the same day. Sometimes, you see traders buying and selling the same stock within a few hours. If you’re aware of relevant regulations, you may wonder how settlement doesn’t become an obstacle for day traders?
Day traders get around settlements by using margin accounts, which settle most purchases almost instantly. Those using cash accounts have to wait for the funds to get processed via ACH, taking up to three days. Day traders using cash accounts can make only a few trades per day.
In this article, you will find out what the settlement period is and whether it is mandatory to wait or not. You will also learn more about margin accounts and their benefits. By the end of this read, you will have a more substantial knowledge base from which you can decide how to proceed with your day trading journey.
IMPORTANT SIDENOTE: I surveyed 1500+ traders to understand how social trading impacted their trading outcomes. The results shocked my belief system! Read my latest article: ‘Exploring Social Trading: Community, Profit, and Collaboration’ for my in-depth findings through the data collected from this survey!
Table of Contents
What Is the Settlement Period for Cash Trades?
The term settlement period is often thrown around without sufficient context. As a result, most novice day traders end up believing that the settlement period is a mandatory amount of time they have to wait before selling the stock they purchased. This is not true.
The settlement period for cash trades is three days. This means that the buyer has three days to transfer the funds to the seller. If the buyer manages to fulfill his payment obligation before that, he can settle the transaction and sell the stock immediately. This is not possible with cash trades because of two reasons: the transfer speed and the limit of funds.
When you trade with a cash account, you are working with the money you have. And even if you are fast enough in transferring the money to the seller of a particular stock, when you sell your stock, the buyer on the other end may take up to three days to settle. As a result, you lose access to your money for three days, leaving you with a little amount to trade with.
How Many Daily Trades Can You Make With a Cash Account?
As mentioned above, your transfers’ speed dictates how quickly you can sell the stock you bought. But if you trade with cash, and the amount you ‘earn’ upon a sale may take three days to reach you. As a result, every trade leaves you with little money to buy other stocks.
The number of trades you can make will be covered by the amount of money you have and how quickly you can transfer it. Generally, a day trader using his cash account can make around three trades every day.
What Is a Margin Account?
If you’re interested in trading, you’ve already heard of ‘leverage’. Trading on leverage involves making transactions on borrowed money. Margin accounts allow you to borrow the money you know you have coming. That will enable you to trade with the money you have but can’t access.
For instance, if you bought a stock for $30 and $70 from your previous sale hasn’t reached your cash account, you can use margin to buy the stock you have your sights on without having to go deeper into your wallet.
Unlike general leveraged trading, trading on margin doesn’t result in interest because you’re only borrowing the money you have coming your way. However, if you decide to leverage yourself by making stock purchases despite not having the money in the pipeline, you will almost certainly get financial penalties upon not paying them back.
Usually, margins are offered once a trader has over $25,000 in his cash account. There is little risk or interest involved with margin accounts provided that all parties deal with integrity.
Top Five Reasons to Have a Margin Account
If you’re a day trader or are learning from one, you have undoubtedly been recommended to trade on margin. In this section, we will uncover the top five reasons to trade on margin.
Reduce Waiting Time
If you’re risk-averse and do not want to trade with leverage, you may be cautious of margin accounts. However, the stocks you sell might take three days to settle. As a result, if you’ve spent all your trading dollars buying stock and proceed to sell the stock, you may have to wait up to three days before you have the cash to buy more stock.
This may work for long term investors and even value-based mid-term traders. But day traders won’t be day traders if they allow opportunities to slip by normalizing such waiting periods. A margin account allows you to access the cash you have coming way before it reaches you.
Allows You to Make Multiple Trades
Day trading is all about speed and spotting opportunities. There is no advantage to spotting an opportunity if all your money is locked up in unsettled trades. On the other hand, you can’t sell high if your cash hasn’t been processed and sent to the seller of the stock you’ve ‘paid’ for.
A margin account allows you to circumvent the settlement delays by giving you access to the cash before such transfers occur. This leads to early settlement and often enables you to sell the stock you bought within the same day. This is almost impossible with cash accounts.
Avoid Free-Riding While Reaping the Benefits
Sometimes you don’t have the money for a stock you’re bullish on. If only you had the money, you are confident you could buy it and sell it shortly after to pay yourself the difference. Unfortunately, doing so would be considered free-riding and restrict you to cash settlement trades only were you to get flagged for it.
But with a margin account, you can benefit from making such trades by leveraging yourself and buying the stock using the money lent by the margin provider.
Gives You the Opportunity to Cover Your Losses
Day traders understand that not all their trades will lead to a profit. It is usually assumed that a trader will make a few profitable trades that will cover the losses of all the bad ones. Unfortunately, working with a cash account would mean that upon losing any money, the trader also loses his ability to trade with the amount.
With a margin account, if you lose $50, you can borrow $200 to offset the loss with your next trade. That said, this strategy is a bit of a double-edged sword.
Streamlined and Efficient
Unlike cash accounts, margin accounts are optimized for fast-paced day trading. Using your cash account to day trade is truly like using your feet to walk between states. There are physical limitations, delays, and unpredictability. On the other hand, using margin is like taking a car. This option is meant for the distance you wish to go like margin accounts are intended to ease the buying and selling of stocks on short notice.
Can You Day Trade Without a Margin Account?
While there are many benefits to margin accounts, you must meet some requirements before being eligible for margin. For instance, if you don’t have $25,000 in your account, you can’t get margin as a pattern day trader.
But you can day trade without margin as long as you stick to three trades or less per day. If you exceed this number, you are likely free-riding. You also have the option to use margin as a non-pattern day trader with only $2000. This will allow you to get limited benefits.
Author’s Recommendations: Top Trading and Investment Resources To Consider
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Conclusion
If you’re a day trader who plans to make his profit from timely calls, then you must be willing to act in an instant. For that, waiting three days for settlement is not an option as a buyer or a seller. When you use a margin account, you can get around the settlement and focus on what you do best: day trading.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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