8.3.  Types of Accounts: Cash versus Margin

Accounts can also be classified by the types of transactions that can be executed in them and how those transactions are paid for. When a customer opens a cash account, she must deposit 100% of the cost of the security in the account by the time the transaction settles. Customers are allowed some slack on this rule and are actually allowed two additional business days after the settlement date to pay for the security. During these additional two days, the broker-dealer will cover any payments for the customer. Thus, customers must pay for the security within four business days after the trade date or the transaction will be cancelled.

Freeriding is the prohibited practice of buying securities in a cash account and selling them on or before the settlement date to make the payment. Without enough cash in the account to cover the initial purchase, the trader is relying on his broker for credit and attempting to trade for free. You need a margin account if you expect credit from your broker.

Typically, if a customer is guilty of freeriding, the sell order will go through, but the account will then be frozen for the next 90 days to prevent further freeriding. During this 90-day period, the investor may still purchase securities with the cash account but must fully pay for any purchase on the date