What is free riding?

An illegal operation in which an investor using a cash account buys and sells securities without having the cash to pay for the original purchase.

Where have you heard about free riding?

You’ve probably heard the term ‘free riding’ used to describe a person or group of people who take advantage of public goods without paying for them. The use of the term in stock-trading is more specific, but has a similar concept.

What you need to know about free riding.

If an investor uses a cash account to purchase securities, they must pay for the securities before selling them on. In the United States, there’s a three-day settlement period for securities. If an investor doesn’t have enough cash to pay for their purchase then they may try and sell the securities on the same day and use the money from the sale to pay the purchase price. This is prohibited and can lead to the investor’s account being frozen.

Freeriding can also refer to a situation in which an underwriter fails to place part or all of a securities issue and then sells it at a later time for a higher price.