Wash Trading

Definition

Wash trading is an illegal practice in which an investor buys and sells the same financial instrument simultaneously with the intent to manipulate the market and create an illusion of high trading volume. This deceptive strategy is often used to boost investor interest and confidence in the asset. Wash trading is prohibited by regulatory authorities, as it distorts the market and undermines its integrity.

Phonetic

The phonetic pronunciation of the keyword “Wash Trading” is:wɒʃ ˈtreɪdɪŋ

Key Takeaways

1. Wash Trading is an illegal trading practice which involves simultaneously buying and selling a financial instrument, such as stocks or cryptocurrencies, with the intent of creating an illusion of increased trading activity.
2. This deceptive practice is used by traders, brokers, or market manipulators to artificially inflate the demand and price of a financial instrument, thereby attracting more investors and profiting off of their investments.
3. Regulatory authorities, such as the SEC (Securities and Exchange Commission) in the United States and other similar organizations worldwide, strictly monitor trading activities to prevent wash trading and impose severe penalties, including fines and bans, on those found guilty of engaging in such practices.

Importance

wash trading is important because it has significant implications for the integrity and transparency of financial markets. Wash trading refers to the unethical and illegal practice of buying and selling the same financial instrument with the intent to manipulate the market and generate artificial trading volume, thus creating the illusion of increased demand, activity, or liquidity. This deceptive behavior can mislead investors and regulators, distort asset prices, and undermine the overall credibility of the financial market. As a result, regulatory bodies across the globe are vigilant about identifying and penalizing wash trading to ensure that markets remain fair and transparent for all participants.

Explanation

Wash trading is a financial practice that aims to create the illusion of increased trading activity by executing simultaneous buy and sell transactions in a particular asset, typically by exploiting a loophole or using an arrangement between distinct parties. Its purpose is to manipulate market perception and instill a false sense of demand or liquidity in the asset. This can be done to attract more investors to the asset, as they might assume the increased activity translates to a higher value or popularity. Moreover, the currency or security can achieve a falsely inflated position on trading platforms, which may generate further interest from potential investors who are unaware of the underlying manipulation. Though wash trading is illegal in many jurisdictions, it still occasionally occurs in the financial markets, particularly in the realm of cryptocurrencies where the regulatory environment is less stringent. Instances of wash trading can adversely impact everyday investors by establishing misleading price levels and trading volumes, which may prompt these individuals to make decisions rooted in inaccurate market information. In essence, this deceptive practice distorts the market’s natural course and hinders the proper functioning of price discovery mechanisms, thus compromising the integrity of the financial system.

Examples

1. In August 2013, the U.S. Securities and Exchange Commission (SEC) charged two firms and individuals involved in a wash trading scheme on an electronic commodities trading platform. The firms NextTrade Technologies and Technology Based Solutions, along with their owners, Evan Kopperud and Shawn Baldwin, were accused of orchestrating a series of wash trades to artificially inflate the volume and price of penny stocks they held. The wash trades created an illusion of market interest in the stocks and induced other investors to purchase them, leading to a temporary boost in the stock prices. 2. In February 2014, the Financial Industry Regulatory Authority (FINRA) fined the financial services company, Newedge USA, $9.5 million for failures in risk management and supervisory systems with regard to wash trading. Newedge was held responsible for numerous instances of wash trading that occurred between 2008 and 2012, which had resulted from improper algorithms and inadequate software controls. The company’s failures to adequately supervise and identify wash trading activities constituted a violation of FINRA’s rules. 3. In August 2018, the U.S. Commodity Futures Trading Commission (CFTC) settled charges against Tower Research Capital LLC, a high-frequency trading firm, for engaging in wash trading in U.S. Treasury futures markets. The CFTC found that Tower had executed hundreds of wash trades between 2011 and 2012, resulting in more than $12 million in profits. As a result, Tower agreed to pay a $67.4 million civil monetary penalty to resolve the case. This was one of the largest penalties ever imposed by the CFTC related to trading manipulations, and it highlighted the risks and regulatory scrutiny associated with high-frequency trading activities.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Market Manipulation
• Artificial Trading Volume
• Securities and Exchange Commission (SEC)
• Commodity Futures Trading Commission (CFTC)
• Illegal Trade Practice

Sources for More Information

• Investopedia
• Wikipedia
• Corporate Finance Institute
• SoFi