Under SEC guidelines, a Good Faith Violation occurs when, through a cash account, a security is purchased and is sold before being paid for with settled funds in the account. 

Traders using a cash account cannot sell a purchased stock if it was never paid for with settled funds. In essence, you can not sell out of a stock if you haven’t settled on the purchase - that is the position is liquidated before the cash used to pay for it settled.


Example 1

1. Moses Mentum sells $15,000 in QQQ on Monday morning (settling on Thursday)

2. He then proceeds to buy $14,000 of GOOG later that day with his sale proceeds of QQQ (also settling Thursday).

3. If Moses sells his GOOG stock before Thursday (the day his QQQ settles) he would have incurred a Good Faith Violation, as he has sold his stock before the funds he used to pruchase it settled.

This is a Good Faith Violation 

Example 2 

1. Happy Harry has $10,000 in settled cash in his account. 

2. Harry buys $9,500 of SNAP on Tuesday (Settles on Friday). 

3. On that same day, Harry sells his SNAP shares for $10,500 (also settling Friday).

This is not a good faith violation at this point as Harry had sufficient settled funds to pay for the SNAP shares at the time of purchase. 

4. On Wednesday, Harry purchases $5,000 of KO. 

5. A good faith violation will occur if Harry sells KO before Friday (the settlement date for his SNAP sale).

This is a Good Faith Violation because Harry’s account would not have settled funds from the SNAP sale and were available to pay for the KO purchase.

Consequences

If you incur 3 Good Faith Violations in a 1 year period, your brokerage firm can restrict you account. For 90 days, you will be required to have the cash upfront before you can purchase more securities.