Unveiling cross trading: mechanisms and in-depth analysis

Trading on the Cryptocurrency markets involves various practices and mechanics, some of which lie on the edge of morally and legally accepted exercises.

One of these highly debated practices on brokerages is cross trading. A method when the same security is bought or sold off the ramp of the public order book, whilst not recording the trade on the exchange floor.

Even though cross trading is not permitted on most exchanges, it can be legally executed following necessary regulatory criteria.

The relevance of this phenomenon to the financial markets, and its practical necessity for use, is deeply embedded in the functionality it provides for exchanges and investors.

What is cross trading?

Cross trades take place when a portfolio manager or the broker matches buy and sell orders for the same security at the same price that results in transferring assets between two separate client accounts without passing the trade through the public market.

Such trades are considered technically legal if the broker subsequently records them as cross trades and publishes relevant data to the exchange in a timely manner.

Apart from that, the execution of such trades must be carried out at the prevailing market price. Only then is this process counted as fully legal and appropriate activity.

Regulatory concerns

Given the fact that cross trading means being executed unofficially and on off-exchange boundaries, they remain vulnerable to misconduct and various forms of manipulation.

Because of these stipulations, many exchanges do not permit cross trading due to local regulations. Others simply choose to avoid facing legal consequences associated with incorrect implementation and utilisation of such practices.

However, executing these trades in strict accordance with legal requirements ensures that these transactions fall within the proper regulatory classification, allowing the parties involved to exchange freely within the boundaries of the law.

How does a cross trade take place?

For a cross trade to occur, two clients on one exchange must select the same asset or Stock to trade, with a specific price determined.

Once these orders are placed by market participants they are received by the broker. If they are identified as matched by all necessary criteria, the brokers asset manager can resort to executing a cross trade.

For example, a trader wants to place a sell order for $1,000 on BTC/USD at the market price of $35,500. And another trader desires to place the exact same buy order at $35,500 as well.

The same asset manager for both client accounts will match the buy and sell orders and execute them offset, without recording the transaction on the exchange. This way filling them internally, satisfying both clients.

After this they will report to the exchange that the transaction was executed as a cross trade for different clients.

A time-stamped order, with matching order volume, and a fair market price provided at the moment of execution for both customers, serves as proof that the transaction complies with all regulatory classifications.

Why cross trade orders have a negative reputation

The highly debated transparency of cross trades, and the frequent misconduct with their mechanics, have a close relation to market players, and the unscrupulous brokers that take advantage of them to defraud millions of unsuspecting traders.

Brokers heavily engaged in exercising cross trading often disregard the obligations of proper reporting and informing their customers of fair prices, while running misleading campaigns to attract thousands of investors which fall victim to their practices.

Regulatory oversight

Any Stock exchange involved in cross trading has the right to execute such transactions at will, as long as they abide to the rules and regulations of the securities and exchange commission (SEC), in particular, Rule 17a-7 of the Investment Company Act of 1940.

This rule, along with other provisions of the SEC imply a number of requirements to be met for such transactions to be considered legal, including:

  • The traded security in question must have available and accessible quotations that correspond with the current market price for buy and sell orders for all parties involved, including highly volatile securities.
  • Transactions carried out must adhere to each policy of the fund they interact with.
  • Derivatives trade hedges are permitted when matching orders via cross trading.
  • Block orders may also be carried out by cross trades under special conditions.
  • Recording transactions is not mandatory when client’s assets are being transferred between accounts.

Ethical implications

On the other hand, the execution of cross trades comes with inherent pitfalls and ethical implications, due to a lack of appropriate reporting for such transactions.

Since a cross trade is neither listed nor reported on the exchange, other market participants may not be aware that a better price was available on the market to trade the asset at more favourable conditions.

It is also worth mentioning that while cross trades permitted under specific regulations do not break the law, malicious investors can still misuse them for their advantage.

By creating an appearance of substantial trading activity for the targeted security with unrecorded cross trades, they could mislead other market participants, which is also considered unethical.

Who conducts cross trading?

While cross trading is popular among high net worth institutional investors and hedge funds, individuals also resort to this trading strategy.

Individual investors trading highly volatile securities often express heightened interest in cross trading, as it enables them to enhance their entry price into the market.

Some brokers also have a genuine interest in cross trading due to the ability to decrease latency while executing transaction.

Pros and cons

Like any other practice in the financial sphere, cross trading has its advantageous and destructive sides. Here are just a few you might want to note:

  • Advantages: an essential advantage of a cross trade is the ability for a trader to improve their entry price and buy or sell an asset at a specific price point, instead of joining the public order book.Cross trades also allow participants to eliminate brokerage fees in the form of spread, at the cost of waiting for the order to be matched and executed. Which helps save money over time.Another upside of adopting a cross trade strategy is the benefit of receiving a 1:1 ratio deal with another participant of the market, and the absence of needing to settle for worse order conditions.
  • Disadvantages: unlike orders placed into the order book, a trader engaged in cross trading cannot place a stop loss or take profit order to protect his investment or capture profit.Additionally, cross trades are sometimes used maliciously to manipulate prices and create fictional trading volumes, which may inflict damage on other participants as they make uninformed and blind decisions.Moreover, the off-ramp nature of cross trades simply excludes other investors from making more beneficial trades at prices available only to involved parties of the cross trade.

The future of cross trading

The future of cross trading is uncertain, as many factors continue undermining the trust of investors in this practice. While many see this method of trading beneficial, some remain hesitant.

Nonetheless, the effective transaction execution and the reduction of transaction costs makes this practice an efficient method. Specially when it comes to the latest industry changes, where more brokers are complying with regulations.

Conclusion

Cross trading is an acceptable practice when executed in accordance with regulatory conditions and requirements. Additionally, it provides improved transaction processing and a substantial cut on costs.

However, some brokers tend to misuse this trading method to manipulate prices and undermine the actual market sentiment, by ignoring proper reporting of the offset transactions.

It is vital to always conduct your own research and analysis of the underlying asset before making any financial decision to trade or exchange a security with an outset strategy, including cross trading.

Risk Disclaimer
Investing in or trading gold or other metals can be risky and lead to a complete loss of capital. This guide should not be considered investment advice, and investing in gold CFDs is done at your own risk.
The information provided does not constitute, in any way, a solicitation or inducement to buy or sell cryptocurrencies, derivatives, foreign exchange products, CFDs, securities, and similar products. Comments and analysis reflect the views of different external and internal analysts at any given time and are subject to change at any time. Moreover, they can not constitute a commitment or guarantee on the part of PrimeXBT. The recipient acknowledges and agrees that by their very nature any investment in a financial instrument is of a random nature and therefore any such investment constitutes a risky investment for which the recipient is solely responsible. It is specified that the past performance of a financial product does not prejudge in any way their future performance. The foreign exchange market and derivatives such as CFDs (Contracts for Difference), Non-Deliverable Bitcoin Settled Products and Short-Term Bitcoin Settled Contracts involve a high degree of risk. They require a good level of financial knowledge and experience. PrimeXBT recommends the consultation of a financial professional who would have a perfect knowledge of the financial and patrimonial situation of the recipient of this message and would be able to verify that the financial products mentioned are adapted to the said situation and the financial objectives pursued.

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