Investing in stocks can be thrilling, but if you’re new to it, especially using Nigerian brokerage platforms, you may feel a bit overwhelmed by the specific rules and regulations. One rule that might catch you by surprise is the “good faith violation.”
You might have seen a warning for it in your cash account and wondered what it meant. Understanding a good faith violation will protect your account from unexpected restrictions and help you trade with more confidence.
In Nigeria, more individuals are investing in stocks, with cash accounts often being the first choice. Because a good faith violation can impact your trading freedom, let’s break down what it is, why it matters, and how you can avoid it to keep your account running smoothly.
What is a Good Faith Violation?
A good faith violation (GFV) happens in a cash account when you use “unsettled” funds to make a stock purchase and then sell that purchase before the funds actually settle. In both U.S. and Nigerian stock markets, cash accounts are subject to settlement rules to prevent investors from buying and selling with money that hasn’t officially cleared.
The settlement time for stocks is usually T+2 (trade date plus two days), meaning the funds from a sale aren’t considered fully available until two business days after the transaction. For example, if you sell shares in Company A on Monday. The funds from this sale will not officially settle until Wednesday. On Tuesday, you decide to buy shares in Company B using the proceeds from the Company A sale.
However, if you decide to sell the shares in Company B before Wednesday, you’ve triggered a good faith violation because you used unsettled funds to make the second purchase.
Why Do Good Faith Violations Happen?
Good faith violations often happen when traders are excited about new opportunities and unaware of the settlement period. For Nigerian investors, this can be especially common if you’re trying to maximize your cash account or are simply unaware of the specifics of cash-based trading rules.
Since this rule is in place to keep trades secure, brokers and regulators monitor for violations and may impose penalties when they occur.
What Happens If You Get a Good Faith Violation?
In most brokerages, you’re allowed three good faith violations within a rolling 12-month period. If you hit three, your account could face a 90-day restriction. During this period, you’re restricted to buying and selling only with funds that are fully settled, making it difficult to trade as flexibly as you might prefer.
If it’s your first violation, the brokerage might offer a warning or educational material instead of enforcing a penalty. However, multiple violations signal a pattern of disregarding the settlement rules, and brokers are quick to impose restrictions to ensure compliance.
How to Avoid Good Faith Violations
To avoid good faith violations, here are some reliable strategies Nigerian investors can use:
1. Trade Only with Settled Funds
The simplest way to avoid good faith violations is to always make sure your account balance has fully settled funds. Avoid buying new stocks unless you’re certain the money from a previous sale has settled, especially if you’re considering active trading.
2. Familiarize Yourself with Settlement Times
Settlement periods can vary by asset. Stocks typically settle in T+2, while other assets may vary by brokerage. Check with your brokerage for details on their specific settlement timelines so you can plan your trades accordingly.
3. Maintain a Cash Reserve
Keep a small portion of your account balance in cash so you’re never caught off guard by the need for funds. Many Nigerian traders find this helpful, as it allows you to act on new opportunities without relying on funds from recent trades.
4. Consider a Margin Account (If Available)
A margin account allows you to borrow funds to buy stocks, bypassing the need to wait for a previous trade to settle. Although this avoids good faith violations, margin accounts come with their own risks, such as additional fees, interest charges, and the need to meet margin maintenance requirements. Not all Nigerian brokers offer this, so check if it’s available to you and consider the risks carefully.
5. Plan Your Trades
Planning your buys and sells according to the settlement period can save you the hassle of unintentionally violating trading rules. Most brokers offer tools for tracking your trade status and can send you alerts when funds are fully settled. Use these resources to monitor your account.
A Practical Example
Let’s say you have a cash account balance of ₦500,000, with no other settled funds available. You sell shares of Company X worth ₦300,000 on Monday, which will not fully settle until Wednesday. The next day, Tuesday, you use those funds to buy shares in Company Y for ₦300,000.
However, the value of Company Y shoots up by Wednesday, so you decide to sell it immediately for a profit. This is where a good faith violation would be flagged because the funds from Company X hadn’t settled by the time you sold Company Y.
Clearing Up Common Misconceptions
1. “I only trade with my own money, so I can’t get a violation.”
Even if it’s your cash, using it before it’s officially available (settled) can still trigger a good faith violation in cash accounts. Brokers follow these rules to keep trading fair and manageable for all investors.
2. “Good faith violations don’t affect my account directly.”
Good faith violations do have an impact, as repeated offenses can restrict your account to only fully settled funds. This could reduce your flexibility, especially if you’re actively trading and relying on quick fund availability.
3. “Good faith violations apply to all types of accounts.”
Good faith violations are specific to cash accounts. If you’re using a margin account, you’re less likely to encounter this violation, though margin trading involves its own set of rules and requirements.
Conclusion
Understanding good faith violations is an essential part of successful trading in Nigeria’s growing stock market. By staying aware of the T+2 settlement rule, you can avoid account restrictions and make informed trading decisions. Using only settled funds and planning your buys and sells carefully keeps you on the right side of brokerage rules and helps you build good trading habits.
As Nigerian investors continue to explore the stock market, being informed of these regulations will prevent unnecessary roadblocks and encourage more productive, hassle-free investing.
