Trade Date Basics
When you want to buy or sell shares of stock, you call your broker and ask for a stock trade or go to your online account and place an order yourself. On a market order, your trade is typically executed within a few seconds. On a limit order, your trade may or may not happen that day. The actual date your trade is executed is known as the trade date. This is the date your purchase or sale technically happens and the date used for tax purposes.
Settlement Date Basics
In general terms, a settlement date is defined by Business Dictionary as the date by which a sale is "consummated". A seller must deliver the goods or service and a buyer must deliver payment for what is purchased. In investing, settlement dates are often associated with stocks, but they are also common to bond markets and other financial investment markets. The settlement date on a stock trade is typically three days after the trade date. In bonds, the settlement date is one day after the trade date. According to The Motley Fool's "Trade Dates vs. Settlement Dates" article from February 2005, "The settlement date is just the date when the cash or securities from the transaction are plunked into your account."
Why the Difference?
Since much of what individual investors experience with the stock market goes on behind-the-scenes, many do not understand the importance of the three-day wait for settlement on stock trades. While investors often trade electronically, physical processing of trades involving exchanges between brokers of securities and funds takes time. Technically, when you execute a trade for sale of shares you own, you have completed the sale. However, physical funds are not in your account and available for withdrawal until three days later. This is similar to selling physical property. If you sell a home, you have legally sold the property at the signing of the sales contract by both parties (excluding contingencies). However, you do not receive funds from the sale until the closing date.
Individual investors are typically only impacted by settlement dates when waiting to withdraw funds or attempting to make a new trade with unsettled funds. With a cash account, you are required by the U.S. Securities and Exchange Commission to pay for a particular security before you can sell it. Failing to do so is called "freeriding," which is prohibited under the SEC's Regulation T. Your broker must suspend your non-cash trades for 90 days if this happens. As an example, if you sell 100 shares of a stock on Monday, April 4 at $5 per share, you are due $500 on the settlement date of Thursday, April 7. You can purchase new shares with the unsettled funds, but you must hold the new stock until the original sale settles on April 7. This is a risk if you buy a stock that tanks and cannot sell for a couple days.