Also known as round trip trading or painting the tape, wash trading is an unethical practice designed to convey a false impression of the desirability of an asset as an investment opportunity. The process typically involves either making simultaneous buys and sells of securities issued by a specific company in order to create the impression of demand for those securities. An alternative version of wash trading is to create the impression that these transactions have taken place when in fact no such transactions occurred. Both approaches are designed to stimulate interest in the securities and motivate investors to quickly move to acquire any currently available shares.
In order to avoid giving the impression of engaging in wash trading, an investor attempting to employ this strategy will usually place an order to buy shares with one broker, while simultaneously placing an order to sell those same shares with a different broker. In theory, the two brokers would not be aware of the attempt at manipulation, and would execute the orders according to the investor’s instructions. As a result of the activity, a false impression of activity on the stock is created in the marketplace. Assuming the strategy is successful, the increased interest in the stock makes it possible for the investor to ultimately sell the shares for a unit price that would not have been possible otherwise.
Wash trading can also be conducted by discreetly putting out the word in the investment community that certain parties are interested in a given security, and that something major is about to happen with the company that issues the shares that will trigger substantial growth. This is often augmented with rumors of impending trades by those interested parties, a ploy that can sometimes cause other investors to also take steps to buy outstanding shares while they are still available. By the time the rumors are proven false, the instigator has unloaded his or her shares for a lucrative amount. Investors who thought they were about to earn a significant return are left holding stock that is generating a return that is no different from before the advent of the rumors.
Today, many exchanges have strict rules against the use of wash trading to manipulate the marketplace. In addition, a number of governmental regulatory agencies have also declared the practice to be illegal, sometimes considering the manipulation to be a form of stock fraud. Investors who are found engaging in this type of activity are often subject to censure on the part of the exchanges and may face penalties or possibly imprisonment for the attempt to defraud other investors.