Posted in Finance, Accounting and Economics Terms, Total Reads: 447
Definition: Circular Trading
This refers to a fraudulent trading scheme where a broker or trader or another person’s in collusion with each other enter into sell order exactly offsetting the buy orders since they have prior information. This is done to operate the price of the underlying assets by increasing the volume of trade.
They are aware of the exact number of shares at the exact time for the exact price that should be entered to neutralize or offset the deal. This discourages competition and there is no change in the beneficial ownership of the security. When the trading volume increases, there is a false belief among the investors about a major event such as a merger or an acquisition ahead and some day traders or small investors may lose money in this process.
If there is any major news about the firm say M&A or bonus or earnings release, traders involved in this phenomenon will enter into matching orders among them at the same price. (Trader 1 sells a security (stock) to Trader2 who will sell the same stock at the same price to Trader 3 who will in turn sell at same price to Trader 4 at the same time increasing the volume of trade). Gullible investors will buy this stock and the traders involved in circular trading will start making profit and exit the deal while these investors suffer a loss because they are not cognizant of the situation.
This is normally done in an IPO to increase the liquidity and distribution of the stock. After the initial whirl most of the IPO listed stocks will come down. This phenomenon also observed in penny stocks trading because they might gear the prices for some time and exit when the target is realized. We can identify this by counting the number of trades because mostly circular trading is done in bulk.
In India’s biggest stock market scam (1999-2001), Ketan Parekh was alleged to have been involved who was debarred till 2017 from trading in the Indian stock exchanges. He was accused of circular trading, inflating prices of the firms like Zee, Ranbaxy, Global Telesystems, and Satyam Computers etc.