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Do you know how circular trading creates fake volume?
Circular trading is a type of securities fraud that occurs in the stock market and is used to manipulate prices, often in conjunction with a "pump and dump" scheme. When circular trading occurs, identical buy and sell orders are entered at the same time for the same quantity and price. The result is that the actual ownership of the equity has not changed, but there has been an increase in trading volume.
The basis of circular trading is that there is a direct influence relationship between trading volume and stock price.
The act usually involves several colluding participants with the purpose of achieving a fraudulent outcome. It is important to note that circular trading should not be confused with “wash trades,” which are actions by a single investor that produce similar results. The essence of cycle trading is the generation of false signals, which trick investors into trading without any real information.
The false trading volume caused by circular trading can encourage investors to buy stocks and even exacerbate the rise in stock prices, ultimately creating an imbalance between supply and demand. Such operations are most common in countries such as India, and can even lead to inflated company stock prices.
Market Impact
In the most common form of circular trading, a group of investors illegally bid up a company's stock price and then sell it for a profit. Although the practice is illegal, the consequences in the marketplace are often minimal. In some cases, circular transactions can directly affect the success or failure of a company.
Once these price thresholds are identified, cycle traders may manipulate the stock price to keep it above the most favorable price threshold.
In addition, circular trading also has serious consequences in initial public offerings (IPOs). The success of an IPO is closely related to the heated discussion and hype from the outside world. If there is manipulation of enthusiasm in the market, it may cause the company to over-expand, and ultimately investors will face potential losses.
Case Study
Most of the high-profile cases surrounding circular trading have occurred in India. In 1999, Ketan Parekh, a stockbroker who attempted to carry out circular trading, was convicted of major market fraud. As many as seven companies colluded to illegally manipulate market influence, resulting in investors receiving wrong market signals before the IPO.
Another high-profile case occurred in 2001, when the Securities and Exchange Board of India (SEBI) found that Angel Broking had created fake trading volumes for Sun Infoways Ltd over a short period of time. Continuous manipulation caused stock prices to drop sharply after temporary highs, undermining the confidence of real investors.
When circular trading is discovered, it can have a negative impact on consumer confidence in the entire stock market.
Regulatory measures
Since 2010, the Securities and Exchange Board of India has taken several steps to prevent circular trading and strengthen market regulation to limit high trading volumes of stocks in a short period of time. This includes setting price limits to prevent the growth of false trading volume.
Such measures face the contradiction of how to effectively balance real market demand and prevent fraudulent activities, especially in certain high-volatility products, where appropriate price limits may hinder normal market development.
Future Outlook
With the advancement of technology and data analysis, ongoing research is exploring more effective methods for detecting circular transactions. Scholars hope to identify suspicious transaction behaviors by analyzing transaction networks. The results of this study may help to identify cyclical traders in the market more quickly and accurately in the future.
As the market develops, the risk of circular trading always exists. Are investors truly able to discern the truth in the market and make wise decisions in the face of asymmetric information?
