If security purchased through a customer’s cash account is sold before being paid for with settled funds in the account, a good faith violation has occurred. It is referred to as a good faith violation because that trade activity gives the appearance that sales proceeds are being used to cover buy orders when there is insufficient settled cash to cover these purchases. Trade activity indicates that a good faith effort to deposit additional cash into the account will not happen.
Accounts with three good faith violations in 12 months will be restricted to purchasing assets with settled cash only for 90 days.
Here’s an example:
Ms. Sudha has a US brokerage account with $1,500 cash in it, fully settled.
On Monday afternoon, Ms. Sudha purchased $1,500 of X stock. She sells the X stock for $1,600. The funds from the sale are expected to settle on Wednesday. Up till now, this is not a ‘good faith violation’ as her account was fully funded to pay for the purchase of the X stock.
However, during the closing hours on Monday, Ms. Sudha purchases $1,600 of Y stock again. There is still no good faith violation incurred.
The next day (Tuesday), she sells her entire holding of Y stock and thus suffers a GFV. This Tuesday's trade is a violation, as Ms. Sudha sold the stocks she bought with unsettled funds.
Buying a stock with unsettled funds is not a violation, but selling the same even before the said cash is settled leads to the violation. Violation can be avoided by selling the stocks that were bought with unsettled cash after the cash settlement.
A settled fund means the amount is settled in your account and can be used to trade or withdraw, whereas an unsettled fund is the amount to be received from the Sales proceeds and is in the process of being settled for you to use the same.