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Have you ever felt the sudden urge to buy a stock as soon as you see it fall sharply? Many investors are often tempted to do so as their minds immediately begin to see an opportunity to buy the stock at a discount. Though it is true that sudden drops cause stock sales, the 3-day rule explains why investors should wait a full 3 days before buying shares of the underlying stock.
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There are many written and unwritten rules regarding topics that different types of investors or traders often abide by. While most apply to select groups, the 3-day rule is one that anyone who participates in the stock market can incorporate into their strategy.
In short, the 3-day rule dictates that following a substantial drop in a stock’s share price — typically high single digits or more in terms of percent change — investors should wait 3 days to buy.
Sudden drops in stock prices can trigger margin calls in accounts that either bought the stock using leverage or entered into options contracts using leverage. These margin calls can trigger additional sales the next day, driving the price down further.
Additionally, institutional investors that want to exit a position almost never dump their shares all at once, instead electing to spread their sales over the span of 2 to 3 days. The reason for this is because high sell volume will cause a stock to nose-dive, so instead of selling as fast as possible, they sell over the course of a few days to maximize their selling price. This continued selling forces the stock to drop more but not to the same extent as the initial drop.
Certain brokers allow you to see what percentage of a company’s shares are held by these institutional investors, a tool that can be helpful in determining how long or impactful an institutional sell-off may be.
Finally, volatility and options activity often come hand-in-hand. On large drops, many options traders look into contract pricing and execute orders. Because these trades are derivative contracts (see Beginner’s Guide to Derivatives Trading), orderflow does not directly impact the stock on that first day. Instead, option orders settle the next day.
By waiting 3 days to buy into a position, you can grow your profits and lessen your losses. Considering that most stocks trend lower in the days following an initial drop, you can lock in a better purchase price if you are patient.
Waiting 3 days also gives you the opportunity to analyze and understand the underlying news or event that caused a stock to dip sharply — you would regret instantly buying into a stock that has dipped 50% if you later found out that the reason was because the company was going under.
If you are not familiar with the company, take some time to do the research.
First, make sure you understand why the stock dropped to begin with. Was it definitive news that is detrimental to the company’s future, news causing uncertainty around a company’s future, selloff related to another stock, or simply bad PR? Understanding why the stock dropped is crucial as you will not see future gains on shares if the company’s future is dead.
Second, read about the company you are buying. What do they do? How do they make money? How risky is the business? You would not buy a new pair of shoes if you did not know anything about them. Additionally, take a look at the price history. If the drop has brought the stock back to a price range it normally trades at, maybe the price it fell from was because of a period of volatility and the drop was just a correction.
Finally, learn about how the company fits into its industry and where it trades relative to peers. If the company is in a dying industry it may be safer to stay away from the stock. You can use different multiples such as P/E, EV/EBITDA to see how the stock is valued relative to its competitors.
When you’ve done your due diligence and have decided that the investment is sound, add the stock to a watch list so you can continue to follow its price movements. Adding the equity to your stock market watchlist can also help you to not forget the name.
In terms of the SEC 3-day settlement rule, there are no exceptions in that a share must be transferred and settled within 3 days of a sale.
When talking about the trading strategy, investors may want to be wary of trading with the 3-day rule in the following scenario.
In the event that stock market participants discover a drastic change in business fundamentals or the viability of a business and/or its goods or services, the drop in share price is not a discount for the stock, rather a repricing.
Let’s use Nikola in September 2020 as an example. Up to this point Nikola was one of the hottest names in electric vehicles. The company’s share price was surging all summer, at one point hitting a high of nearly $55 per share on September 8.
On September 10, short-seller Hindenburg Research released a scathing report exposing that everything the company had promised was a lie, from the fully electric trucks to its hydrogen fuel station network.
This caused the stock to plummet nearly 30% from market close on September 9 to market open on September 11. By the 3rd day after the initial drop, the stock had fallen nearly 35% to $32.83. If investors followed the 3-day rule, they would have seen that the stock hit continued to drop through that 3rd day, marking a buying point.
Since then, however, the stock has halved and lately hovers between $13 to $17, only passing the $32 mark in the final week of November 2020. Nikola will likely not return to its highs in the near future as the company is now worth significantly less than it was before the lies were uncovered, meaning that investors who bought in 3 days after the initial drop will likely need to sell for a substantial loss.
Check out some of our favorite online stock brokers below.
It seems like new digital investment management platforms are sprouting up left and right, and for good reason — there’s a great need for easy, straightforward investment management that doesn’t cost an arm and a leg in fees or to get started. If you’re new to investing or an old hat who wants to make the switch to a virtual manager, deciding which features you need can be confusing if not overwhelming.
If you want a no-frills financial management platform, Axos Invest (formerly WiseBanyan) takes a traditional but sophisticated approach to automated online investing.
Public.com is an investing platform that helps people become better investors. Members can build a diverse portfolio of stocks, ETFs, and crypto within a single platform. Ownership unlocks an experience of content and education, contextual to their portfolio, created by an over million strong community of investors, creators, and analysts.
Public puts investors first and doesn’t sell trades to market makers or take money from Payment for Order Flow (PFOF).
Webull, founded in 2017, is a mobile app-based brokerage that features commission-free stock and exchange-traded fund (ETF) trading. It’s regulated by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA).
Webull offers active traders technical indicators, economic calendars, ratings from research agencies, margin trading and short-selling. Webull’s trading platform is designed for intermediate and experienced traders, although beginning traders can also benefit.
Webull is widely considered one of the best Robinhood alternatives.
Cobra Trading is a direct access broker focused on access to short opportunities and order execution. Cobra has multiple short locate sources, giving traders access to the best short opportunities in the market. Cobra Trading also specializes in offering comprehensive, responsive customer service throughout the trading day. We recommend Cobra Trading to high-volume traders and short sellers.
Moomoo is a commission-free mobile trading app available on Apple, Google and Windows devices. A subsidiary of Futu Holdings Ltd., it’s backed by venture capital affiliates of Matrix, Sequoia, and Tencent (NASDAQ: FUTU). Securities offered by Futu Inc., regulated by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA).
Moomoo is another great alternative for Robinhood. This is an outstanding trading platform if you want to dive deep into smart trading. It offers impressive trading tools and opportunities for both new and advanced traders, including advanced charting, pre and post-market trading, international trading, research and analysis tools, and most popular of all, free Level 2 quotes.
Get started right away by downloading Moomoo to your phone, tablet or another mobile device.
TradeZero is an online broker and free stock trading platform that provides everything you need to successfully share and trade, including round-the-clock customer support. TradeZero provides four different trading state-of-the-art software programs with its services, a locator for sourcing shares for shorting, commission-free trades, and real-time streaming, to name a few of the features promoted on their website. The software is a unique and (potentially) affordable option for anyone interested in stock trading.
Everyone is always looking for a good sale. By having a little bit of patience and following our advice above, you will be able to get in on even greater stock sales than anticipated.
At this point, you are probably wondering how you are going to find and identify stocks offering the best discounted prices. Thankfully, Benzinga does the hard work for you and lists the top gainers and losers of the day on its Stock Movers page.
After you trade a stock ownership of that share transfers, however, the shares themselves will not transfer until 3 days later. This is due to the SECs 3-day settlement rule or T+3 Settlement Cycle. The reason for this rule is so that people or computer algorithms at clearinghouses and brokerages can verify the trade, ensure both the buyer and seller account numbers are valid, and make sure other details such as who should receive a dividend payment for the shares are hammered out.
The SEC amended the rule in 2017 to 2 days to account for the speed of new technology and increased trading volume, yet it is still commonly referred to as the 3-day settlement rule.
With the innovations in fintech bringing us new technology, trades and shares are being executed and transferred faster than ever before. It is possible to buy and sell a stock within 3 days, however it is vital that you make sure you’ve fully paid your purchase price at the time you wish to sell your stock. If you pay for part of your stock with unsettled cash and then sell the stock before you have fully paid, you could be committing a free-riding violation, which carries a 90-day account freeze. Trading stocks daily should not be an issue through most brokers, but your safest bet is to verify with your individual broker firm.
0 Commissions and no deposit minimums. Everyone gets smart tools for smart investing. Webull supports full extended hours trading, which includes full pre-market (4:00 AM – 9:30 AM ET) and after hours (4:00 PM – 8:00 PM ET) sessions. Webull Financial LLC is registered with and regulated by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA). It is also a member of the SIPC, which protects (up to $500,000, which includes a $250,000 limit for cash) against the loss of cash and securities held by a customer at a financially-troubled SIPC-member brokerage firm.
5 Stocks from Webull
1 Stock from Moomoo
1 Stock from Robinhood
1 Stock from Public
$150 from Axos Invest
For brokerage reviews, Benzinga created a weighted scale based on the following criteria: usability, services offered, customer service, education, research, mobile app, account minimums and fees. We aim to provide the most up-to-date, impactful and trustworthy reviews. For an in-depth look at our process, read the full methodology process.
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