What is over-trading?
Broker firms usually set a limit for trading in cash accounts. Cash account clients are expected to trade within the limit and settle their purchase on or before the settlement date.
However, if cash account clients were allowed to trade and make further substantial purchases of securities notwithstanding that they had not settled, or fully settled, their earlier purchases on the settlement date, this is in effect treating a cash account client as a margin account client.
This practice can have serious consequences:
- The clients concerned (mostly retail clients) might not be adequately aware of the greater degree of risk that they have undertaken, in particular, they might not realise the apparent leveraged nature of their transactions.
- The clients might, as a result, be encouraged, to over-trade.
- The mode of trading in question might not be suitable for the cash clients concerned in light of their investment experience, objectives and financial situation.
How should investors avoid indulging in over-trading?
- Trade within your financial means and understand the risk of over-trading.
- Settle your purchases on or before the settlement date. Stop making new purchases if you are not able to settle the payment.
- Read the client agreement carefully to be sure that you understand what action the broker firm might take if you fail to settle purchases. Note that one of the alternatives available to the broker firm is to liquidate the clients' stock position to cover the amount due without prior notice to the clients.