Self-Trade

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21 Aug, 2024

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Self-Trade is a financial term used for those entities and traders who tend to trade (buy or sell stocks) within themselves. It is mainly used in the financial markets as a manipulative tool to hide the trades conducted or create a false appearance of trading activity in the market.

Initially, this concept occurred in 2014 when there was an unusual level of self-trade in the US Treasury market. In such trades, there is no change in the ownership, meaning the buyer and seller remain the same. As a result, it is easy to manipulate the trading algorithms.

What Is Self-Trade?

Self-trade refers to the market phenomenon in which a single person places a trade. This means that the buyer and seller are the same entities.
These trades had a maximum occurrence in 2014. As a result, the federal government released amendments to the FINRA rules for self-trades.
These trades can be intentional or unintentional, based on the trader. Intentional trades have a motive of creating a fake appearance in the market by placing orders from different trading accounts.
The FINRA has also counted unintentional trades as they misrepresent the active trading activities.

Self-Trade Of Stock Explained

The self-trade of a stock is a market phenomenon in which the buyer and seller in a trade are the same entity. This means that the shares sold might be deposited into the same trading account later on. Thus, a trader may place buy and sell orders simultaneously for the same stock but from different accounts. As a result, it turns out to be intentional self-trading by the trader. However, in some cases, the self-trading can be unintentional as well.

There is a thin line of difference between intentional and unintentional self-trading. In unintentional cases, traders may run different trading strategies, and as a result, the shares might end up in their accounts. In such cases, they may own only one trading account. However, in the case of intentional self-trade, the entities (or traders) may own different trading accounts. As a result of manipulation, the trader may place buy/sell orders from two accounts at the same time. Thus, it may create fake liquidity or a false appearance in the market. But, in reality, the stock is getting artificially inflated for various reasons.

There are various consequences of these self-trades in the equity markets. It affects the price data and stock credibility. Due to this, demand and supply are also influenced. Some brokers may control a segment of the market. Also, other market participants find it indecisive as the occurrence of these trades is high in automated trading systems.

How To Do?

Although many platforms have restricted the use of self-trading practices, they are still prevalent due to their unintentional nature. Let's outline the process involved in these trades:

Creation of multiple trading accounts - The usual mechanism followed by manipulative traders is creating multiple accounts for trading purposes. It means that the trader may own one or more Demat accounts. This allows traders to place multiple trades without detection.
Developing trading strategies - Once a trading account is opened, the entity may fund the account with adequate funds and resources. It enables them to fulfill the account’s basic requirements. In the later stages, the trader can develop trading strategies for their portfolio.
Placing buy and sell orders - It is the most critical phase, in which the trader tends to place buy or sell orders in the market. These orders will be executed from two different accounts. For instance, the trader will place 20 shares of buy order at $100 per share from Account #1 and similar sell order from Account #2.
Monitoring the funds and positions - Lastly, it is vital to look closely at the funds within the account. If the funds are below the margin, attempts should be made to fulfill them, or else the trade might not get executed.

This process allows traders to manipulate markets by creating false impressions of supply and demand, influencing stock prices for their benefit.

Examples

Let us look at some examples to comprehend the concept better:

Example #1

Suppose Kevin is a trader operating in the stock market for around eight years. He also owns a company that provides accounting services to major clients. Over the years, Kevin has created a good amount of wealth from trading activities. However, a significant exposure happened in the last week, which led to his imprisonment for several years.

On investigation, it was found that Kevin was performing self-trading, where he used to place orders from his business account and personal account. However, the frequency of these trades was irregular, occurring four times over two months. As a result, it took a lot of work to detect Kevin's trades. However, in the later stages, the regulatory bodies identified a pattern in some stocks, and thus, it was possible to catch hold of this activity.

Example #2

According to a recent news update as of December 2023, the Financial Supervisory Service (FSS) identified nine securities firms engaged in self-trading. This illegal activity resulted in losses of around $383.44 million. They were later transferred to the client's accounts under the guise of self-trading. The securities firms attempted to transfer losses of one client's account to another multiple times. However, these were mainly regarding the bond-wrap account.

Self-Trade Prevention

There are multiple ways through which trading platforms and regulatory bodies have ensured the prevention of self-trading practices. Some examples include the regulations imposed by the Financial Industry Regulatory Advisory (FINRA) to prevent such trades in 2014. It has issued guidelines for the members and traders that have a procedure for reviewing trading activity. Also, it helps identify patterns or practices indicating self-trade due to a single algorithm or trading desk.

Even in the case of unintentionally conducted self-trading activities, a certain percentage misrepresent the active trading happening in the market. Similarly, even in the United Kingdom, the Financial Conduct Authority (FCA) has issued guidelines to reduce the intensity of such trades in the market, emphasizing the importance of Self-Trade Prevention Functionality (STPF).

Frequently Asked Questions (FAQs)

Are there any penalties for individuals or firms found guilty of indulging in self-trade?

Yes, there are penalties for indulging in self-trading practices. Those who are found guilty may be subject to fines, suspensions, or even legal action for engaging in fraudulent trading and manipulating the market.

How does self-trade affect trading algorithms and market trends?

It has the potential to influence trading algorithms by producing incorrect signals of market activity. This practice can result in poor trading choices. Moreover, it can manipulate market trends and artificially exaggerate trade volumes. This would lead to deceptive price fluctuations and compromise market integrity and efficiency.

How do trading platforms prevent self-trade?

Trading platforms use advanced algorithms and monitoring systems and are essential in stopping self-trading. They identify and flag questionable trading patterns, such as matching buy and sell orders from the same account. In response, these platforms immediately cancel or submit to regulatory authorities for additional examination.