What is Wash Trading? Everything You Should Learn

 

To mislead the market, a trader may engage in wash trading, which involves the repeated purchase and sale of the same security. There are two types of wash trades: those carried out in collusion between a trader and broker, and those carried out by investors who act as both buyers and sellers of the security.

 

Because of the deceptive nature of wash trading, legitimate trading activity on a security may be artificially inflated by making it appear that more shares have changed hands than in reality. The Internal Revenue Service (IRS) does not allow taxpayers to deduct losses from wash trades because wash trading is against the law in the United States.

 

Brokers are not allowed to profit from wash trades under CFTC rules, even if they claim ignorance of their client's intentions.

 

Table of Contents 

- Low-Informed Trading and High-Frequency Trading

- Bitcoin and the Ethics of Wash Trading

- Examples of Wash Trading

- What exactly is "Wash Trading"?

- Reasons for engaging in Wash Trading

- Final Thoughts 

 

Low-Informed Trading and High-Frequency Trading

In 2013, as high-frequency trading was gaining popularity, news of wash trading resurfaced in the media. High-frequency trading is the execution of thousands upon thousands of trades in a single second via the use of extremely fast computers and extremely fast network connections.

 

The easy accessibility of wash trading by firms with this technology prompted then-Commodity Futures Trading Commission Commissioner Bart Chilton to announce in 2012 that he intended to investigate the high-frequency trading industry for violations of wash trading laws.

 

While some of its high-frequency traders engaged in wash trades and other prohibited and manipulative behavior, the Securities and Exchange Commission (SEC) charged Wedbush Securities in 2014 for failing "to maintain direct and exclusive control over settings in trading platforms used by its customers."

 

Bitcoin and the Ethics of Wash Trading

Recent years have seen the introduction of wash trading into the world of cryptocurrencies. There are thousands of cryptocurrency tokens available around the world, and most of them struggle to stand out from the crowd due to claims of popularity and high trading volumes. However, wash trading affects every cryptocurrency, even Bitcoin.

 

Over half of the reported trading volume in Bitcoin in 2022 was found to be fake or non-economic wash trading, according to a Forbes study of 157 cryptocurrency exchanges.

 

The cryptocurrency market is especially susceptible to "pump-and-dump" schemes, in which the price of a token is artificially inflated through a combination of high trading volumes, positive publicity, or the recommendations of industry insiders, allowing the token's current holders to sell at a high price.

 

Wash trading seems to be very common in the cryptocurrency market, and this could be due to a number of different factors. Even for widely used cryptocurrencies like Bitcoin, there is often a lack of standardized approaches to calculating daily trading volume. Because of this, different cryptocurrency exchanges will often report vastly different volumes of past trading. There has been a spate of high-profile public collapses of token exchanges in recent years, highlighting the lack of legitimacy among cryptocurrency exchanges. Due to the market's extreme volatility, traders may be tempted to make frequent purchases and sales. Last but not least, the uncertainty surrounding crypto's legality in the eyes of U.S. and international authorities provides yet another opening for fraudulent exchanges.

 

Examples of Wash Trading

The term "wash trade" refers to a pair of trades that completely nullify each other and have no commercial value. However, they have many different applications within the financial markets.

 

For instance, brokers involved in the LIBOR scandal used wash trades to bribe members of the LIBOR submission panels for the Japanese yen. Officials in the United Kingdom's financial sector allege that UBS traders engaged in nine "wash trades" with a brokerage firm to earn 170,000 British pounds in fees in exchange for the company's participation in manipulating LIBOR rates.

 

In the same way, that wash trades can artificially inflate the price of a stock by increasing its perceived demand, they can also be used to artificially inflate its volume. Let's pretend that Brokerage Firm Y and Trader X conspire to quickly buy and sell Stock ABC. Investors who see buying or selling of ABC stock may decide to join in the action in the hopes of making a profit. As the stock's price falls, XYZ buys it short and makes a profit.

 

What exactly is "Wash Trading"?

When one trader repeatedly buys and sells the same security in order to distort market data, this practice is known as "wash trading." To boost the appearance of a security's trading volume, "wash trading" is frequently employed.

 

Explain the concept of "wash trading."

The Internal Revenue Service considers a sale that results in a loss to be a "wash sale" if it occurs less than 30 days after the purchase of the same security.

 

Reasons for engaging in Wash Trading

At times, wash trading can increase the normal volume of a security's trading, which can in turn encourage more honest trading. As part of a "pump and dump" scheme, wash trading can also be used to inflate the price of security artificially.

 

Final Thoughts 

To artificially inflate trading volume or the price of a security, a trader may engage in wash trading, in which he or she buys and sells the same security on multiple exchanges in a short period of time. Although wash trading can happen in any market for any asset, it has recently become a major issue in the cryptocurrency and high-frequency trading markets.

 

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