Circular Trading in Stock Market
Circular Trading is a form of unethical trading in which the stock price and trade volume are increased without the actual increase in real stock price and trade volume.
Introduction
Circular trading is conducted by two or more market participants who come together and involve themselves in unethical trading on a scrip or stock within themselves. Though there are multiple market participants trading on the stock in the stock market, the stock will return to the initial stock owner at the end of the day's trading session, thus a circular trading is formed.
Example :
Consider a market participant A sells a stock to participant B , who in turn sells the same stock to participant C and C sells the same stock back to participant A. The trading follows a circular pattern, when the stock sold by participant A returns back to A, at the end of the trading session. This circular trading process can involve multiple market participants.
The sale of a stock among multiple participants, but returning back to the initial stock owner, in turn increases the trade volume of the stock.
In circular trading, the number of sell orders and buy orders of a stock with the same number of shares traded and at the same price, but with the increase in volume.
Difference between synchronized trading and circular trading
Circular trading is a form of synchronized trading.
Synchronized trading involves the seller and buyer of the stock executing the trade at the same instance , at the same quantity and at the same stock price.
Circular trading involves multiple market participants who sell and buy stock frequently on a trading day to artificially increase the stock volume and create an effect on the stock price in an unethical manner.
How Does Circular Trading Operate?
Circular trading creates a misguidance on the traded stock by artificially inflating its trading volume affecting the stock price in an unethical manner.
Real Time Case :
In the financial year 2001, SEBI informed a case regarding unethical practice conducted on stock of 'Global Trust Bank' which led to the rise in stock volume and which in turn increased the stock price.
From 1st September, 2000 to 10th October, 2000, the average daily volume trade of the Global Trust Bank was below 38000 on the BSE stock exchange, with its relative stock price was Rs.57 at the end of 11th October, 2000. But from 25th October, 2000 to 23rd November, 2000, the stock trade volume of Global Trust Bank was increased above 770000 at BSE stock exchange with the stock price of Rs. 114 as on 20th November, 2000.
The rise in stock price was more than 100% within a span of 29 trading days. When SEBI investigated this case, it identified that the trade transactions were carried by a set of market participants associated with each other during those 29 trading days. These market participants were fraud, so even though there were a number of stock trades conducted, the actual stock ownership did not change. The fraudulent market participants actually trade the stock between themselves, thus by conducting a circular trading activity to increase the stock trade volume and stock price.
Thus , creating an illusion of rise in demand for the stock in an unethical manner.
How to Prevent Circular Trading ?
As per SEBI's Regulations 2003 on ' Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market' , circular trading is an unethical trade practice which is performed in order to increase commissions, trade volume to artificially increase stock demand and manipulate the stock price.
SEBI monitors market activities under its acts and regulations. If a market participant is found to be involved in circular trading, SEBI takes action on the market participant immediately. These SEBI actions may be a ban on trading, levy of fines or penalties.
To maintain the integrity of the stock market, SEBI ensures that all the stock exchanges set up a daily stock price bank and also weekly stock trading and price limits . The stock exchanges in turn have implemented a stock price surveillance framework to monitor the stock price and trade volumes , it can also identify fraudulent activities like circular trading etc...
Conclusion
Circular trading is an unethical practice that artificially inflates stock prices and trading volumes, creating a false sense of market activity. This deceptive tactic misleads investors and disrupts market equilibrium, compromising the integrity and stability of the stock market. SEBI has established regulations and measures to curb such practices, including daily price bands, weekly limits, and robust surveillance frameworks. However, some instances of circular trading still occur. Continuous vigilance and active participation from all market players are essential to eliminate this fraudulent activity and maintain a fair and transparent market environment.
Disclaimer: This blog is dedicated exclusively for educational purposes. Please note that the securities and investments mentioned here are provided for informative purposes only and should not be construed as recommendations. Kindly ensure thorough research prior to making any investment decisions. Participation in the securities market carries inherent risks, and it's important to carefully review all associated documents before committing to investments. Please be aware that the attainment of investment objectives is not guaranteed. It's important to note that the past performance of securities and instruments does not reliably predict future performance.
Frequently Asked Questions
What is circular trading?
Circular trading is an unethical practice where multiple participants trade the same stock among themselves, artificially inflating its price and volume without any real change in ownership.
How does circular trading work?
Circular trading involves multiple participants who buy and sell a stock among themselves, returning it to the original owner by the end of the trading session, creating an illusion of high trading activity.
What is the difference between synchronized trading and circular trading?
Synchronized trading involves trades executed at the same time and price by prearranged parties. Circular trading is a type of synchronized trading where the stock is repeatedly traded among multiple participants to inflate volume.
How does circular trading affect the market?
Circular trading misleads investors by creating a false impression of high demand, disrupting market equilibrium, and undermining the stock market's integrity and stability.
What measures has SEBI implemented to curb circular trading?
SEBI has set regulations, including daily price bands, weekly limits, and a surveillance framework to monitor and detect suspicious trading activities, imposing penalties on those involved in circular trading.
