As a responsible investor and trader, staying updated with the unscrupulous trading practices that can affect you is crucial. In this article, we will discuss one such trading practice, Circular Trading. It is a practice to artificially inflate the volume of the stock and its price without any real change.
What is circular trading?
According to the Securities Appellate Tribunal (SAT):
– A circular trade happens when two or more persons join hands and start trading in a scrip among themselves.
– Despite multiple participants and trades, the shares return to the initial owners at the end of the trading session, completing a circle.
– To illustrate, A sells to B and B sells to C, and C sells it back to A. The circle gets completed when the shares come back to A. The process can involve multiple players.
The result is an increase in the trade volume without a change in ownership.
In circular trading, the sell orders get offset by the buy orders with the exact number of shares simultaneously and the same price.
Synchronised trade and Circular trade
Circular trading is a form of synchronised trading.
As per SAT, synchronised trade is a kind of transaction where the seller and buyer execute the trade for almost the same quantity and price at the same time.
However, circular trades refer to when several parties enter into a conspiracy and buy and sell shares frequently to influence the stock price.
How do circular trades manipulate the market?
Circular trading helps create a false notion of active stock due to inflated volume influencing the stock price.
Consider this case mentioned in the SEBI document (vide WTM/GA/55/ISD/3/06):
In FY 2000-2001, the trading volumes of Global Trust Bank (GTB) rose significantly, leading to a rise in its price. Here is what happened.
|Period||Average Daily Volume on BSE||Stock Price|
|01-Sep to 10-Oct, 2000
|Below 38,000||Rs57 (on 11-Oct-2000)|
|25-Oct to 23-Nov, 2000
|More than 7,70,000||Rs114 (on 20-Nov-2000)|
Price increased by 100% in just 29 trading sessions
While SEBI investigated the case, it found the following.
– The transactions during the said period were made by entities associated with a particular entity hereafter called ‘A’.
– These entities were phoney, and there was no change in the beneficial ownership of shares. They were merely trading between themselves, conducting circular trading to inflate the volume and price of GTB scrips artificially.
Given the speculative nature of the stock market, increased trading volume creates an impression of increased demand in the market, misleading retail investors to trade in that stock, hurting the market’s integrity.
Measures to curb circular trading
SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 observes circular trading as a fraudulent or unfair trade practice. It says that circular transactions regarding security entered into between intermediaries to increase commission to provide a false appearance of trading in such security or inflate, depress, or cause fluctuations in the price shall be deemed fraudulent or unfair trade practice.
SEBI looks into any suspicious market activity in a scrip under the various provisions of the SEBI Acts and Regulations. And, if any broker or entity is involved in circular trading, it imposes penalties on a case-by-case basis. The penalties vary from barring from trade for a certain period to imposing a fine, depending on the scale anomaly committed.
As a method to prevent circular trading and improve the safety and integrity of the market, SEBI has mandated all exchanges to fix a daily price band and an overall weekly limit for each stock. The bourses have set a dynamic price band for the securities.
The exchanges have put a surveillance framework to monitor price and volume movements and potential market abuses like artificial transactions, circular trading, etc.
The deception of investors by creating a false sense of stock activity through circular trading disturbs the market equilibrium. Circular trading compromises the integrity and stability of the stock market, reducing its credibility in the eyes of investors. Though SEBI and the exchanges have implemented efficient measures to eliminate circular trading, some cases still surface. Let’s hope that we witness zero cases of circular trading in the future with active participation from all market players.