Circular trading refers to a fraudulent practice where multiple entities or individuals engage in a series of trades with the intent to manipulate prices or create artificial demand for a particular asset. This type of trading scheme involves repeatedly buying and selling the same asset among the parties involved to create a false impression of trading activity in the market. You may also hear circular trading referred to as round-trip trading, wash trading, or looping, and it is illegal in California and most financial markets worldwide.
How circular trading works
Circular trading works by creating the appearance of activity in a stock or asset by trading back and forth among a group of people or entities. Imagine if a restaurant had its employees act as customers where they constantly changed disguises to give the perception that the eatery has a constant flow of patrons.
In financial markets, this trading activity can fool investors into thinking that there is genuine demand for a particular stock, which can drive up the price. The circular traders can then sell their holdings at inflated prices, earning a profit at the expense of other investors who bought into the artificially inflated market. Circular trading is among a list of white collar crimes that can be used to hide losses or to manipulate financial statements.
Why is circular trading illegal?
Circular trading is illegal because it undermines the integrity of financial markets and can cause severe market distortions. It can also defraud investors by leading them on with false market activity, causing them to make investment decisions based on inaccurate information.
Circular trading can have severe consequences for both the market and individual investors. It can distort prices and create volatility, leading to losses for investors who bought into the artificially inflated market. In extreme cases, it can bleed into the rest of the market, causing a crash or even a monetary crisis.
Individuals who engage in circular trading can face fines, imprisonment or both. They can also face reputational damage that can harm their future business prospects. Companies that engage in circular trading can face regulatory sanctions, fines or lawsuits that can harm their reputation and financial health.
Steering clear of circular trading
Circular trading is a fraudulent practice that can harm investors, distort markets and undermine the integrity of the financial system that millions rely on. It is illegal in most financial markets worldwide, and individuals or companies caught engaging in this practice can face devastating legal and financial consequences. Investors should be aware of the risks of circular trading and take steps to protect themselves from its potential harm.