Wash trading, a practice that involves the simultaneous buying and selling of the same
financial instrument by the same entity, has a long and intriguing historical background. Its origins can be traced back to the early days of organized financial markets, where it emerged as a means to manipulate prices, create artificial trading volumes, and deceive market participants. The early forms of wash trading can be categorized into two main periods: the pre-regulatory era and the early regulatory era.
In the pre-regulatory era, which spans from the inception of financial markets until the late 19th century, wash trading was primarily driven by the absence of comprehensive regulations and oversight. During this period, traders and brokers had significant leeway in conducting their activities, leading to various forms of
market manipulation. Wash trading, in particular, was employed to create an illusion of market activity and
liquidity, thereby attracting other investors to participate.
One of the earliest forms of wash trading was known as "bucketing." This practice involved brokers matching buy and sell orders internally without executing them on the
exchange. Instead, they would keep the trades "in the bucket," effectively creating fictitious transactions. By doing so, brokers could manipulate prices and deceive investors into believing there was genuine market activity. Bucketing was prevalent in
commodity markets, such as grain and cotton, where traders sought to influence prices for their own benefit.
Another form of wash trading during this period was known as "matched orders" or "matched trades." In this scheme, traders colluded with each other to execute simultaneous buy and sell orders at predetermined prices. These matched orders were not intended to result in any actual change in ownership but were solely aimed at creating an appearance of trading activity. By artificially inflating volumes, traders could entice other market participants to join in, thereby increasing liquidity and potentially driving prices in their favor.
The early regulatory era, which began in the late 19th century and continued into the early 20th century, witnessed the introduction of various regulations aimed at curbing market manipulation practices like wash trading. As financial markets became more sophisticated and interconnected, regulators recognized the need to establish rules and oversight mechanisms to maintain market integrity.
During this period, wash trading took on new forms as market participants adapted to the evolving regulatory landscape. One such form was known as "matched orders with a third party." In this scheme, two traders would execute matched orders, but instead of colluding directly, they would involve a third party who acted as an intermediary. The third party would facilitate the transactions, creating an appearance of legitimate trading activity while still avoiding actual change in ownership.
Another early form of wash trading during the regulatory era was "cross trades." Cross trades involved the simultaneous buying and selling of securities between different accounts controlled by the same entity. By executing these trades internally, market participants could manipulate prices and volumes without attracting attention from external investors or regulators.
Over time, regulators recognized the detrimental effects of wash trading on market fairness and stability. They implemented stricter regulations and surveillance measures to detect and deter such practices. Today, wash trading is widely considered illegal in most jurisdictions and is subject to severe penalties.
In conclusion, wash trading originated as a means to manipulate prices and deceive market participants in the early days of financial markets. Its early forms, such as bucketing, matched orders, and cross trades, emerged during the pre-regulatory and early regulatory eras. These practices exploited gaps in regulations and oversight, creating an illusion of market activity and liquidity. However, as financial markets evolved and regulators intervened, wash trading faced increasing scrutiny and legal consequences.
