What is Cross Trading?

If you are a trader, you must think about how those players make transactions without creating a big impact on the market or if it is possible to make trades without informing the regulatory body. And the answer is yes, it is possible. And it’s called cross trading.

About Cross Trading 🤔

Cross trading is a method that enables two individuals to trade a financial instrument without officially recording the transaction with the relevant stock exchange. This type of trade can only take place when both parties agree on the price of the instrument. The key question here revolves around whether this practice complies with regulations.

In recent years, cross-trading has gained a lot of attention as a way to make stock market trading more efficient and effective. Instead of going through intermediaries, traders can now directly negotiate and execute trades with each other. This approach offers several potential benefits like faster execution times, reduced costs, increased control, and improved privacy.

It’s worth mentioning that cross-trading is not a new concept. It has been around for many years in different forms like block trading and over-the-counter (OTC) trading. What’s new is the growing use of technology to facilitate cross-trading. Electronic communication networks (ECNs) and other platforms enable traders to connect and negotiate trades directly with one another.

Example

Imagine a broker who works with two clients, Client A and Client B. Client A is looking to sell 100 shares of XYZ stock while Client B is interested in buying the amount. In this scenario the broker can facilitate the trade internally by matching these orders as a cross trade without involving the stock exchange. Once the trade is completed, the broker. Timestamps the transaction details, including the cross price and time of execution.

Can Everyone Do Cross Trading?

The answer is no. Cross-trading does not allow most of the stock exchange. It is only allowed in special scenarios, such as when the buyer and seller have the same broker or asset management company and the price of the trade is fair compared to the outside market. Sometimes, people have trust issues when they talk about cross-trading because cross-trading may be the reason for stock manipulation and unfair stock practices.

Also Read:- How to start Forex Trading from India?

Case Studies

The Kyber Network is a decentralized exchange (DEX) that allows users to trade with one another using a cross-trading methodology. The network operates on a reserve basis, in which market makers offer liquidity by depositing cryptocurrency into pools. When a user initiates a transaction, Kyber Network matches their order with the best available price from one of the reserves. This leads to faster execution times and lower costs than typical order book exchanges. 

Uniswap is a decentralized exchange that employs a unique cross-trading strategy known as automated market making (AMM). In this concept, liquidity providers deposit two tokens with equal values into a pool, and the price of each token is determined by a mathematical formula. When a user initiates a trade, the order is executed against the pool, and the price is automatically modified based on current supply and demand. This leads to increased efficiency and lower costs when compared to typical order book exchanges.

Benefits of Cross Trading 

1. Cross trades have greater efficiency than trades on an exchange as they do not require matching with other orders.

2. Cross trades are more cost-saving by avoiding exchange fees, making them more affordable than traditional trades.

3. In certain cases, cross trades can be executed at a better price than what is available on the exchange, especially for large orders that could significantly impact the market.

4. Cross-trades provide more flexibility by allowing customization to meet the specific needs of the parties involved. This includes facilitating trades involving multiple securities or complex conditions that may not be possible on the exchange.

5. Cross trading provides more liquidity and visibility to the foreign issuers by providing access to the U.S. stock market 

Risk and challenges of Cross Trading 

1. Lack of transparency: When cross trades are not documented on the regulatory level , it can lead to a lack of confidence in the market as one or both parties may not receive the same market price as other participants.

2. Price manipulation: Cross trades can be utilized for illegal market manipulation, known as “painting the tape,” where traders buy and sell a security among themselves to create the appearance of high trading activity and impact the price.

3. Regulatory risk: Most major exchanges prohibit cross trades, requiring all orders to be submitted to the exchange and recorded. Violating a regulatory body’s rules with a cross trade can result in penalties from regulators for the broker and manager.

4. Fairness concerns: Some crypto market participants may view cross trades as unfair since they were not given the chance to engage with those orders.

Conclusion

In short, cross trading enables traders to perform financial transactions without telling the stock exchange. This strategy is viable when two parties agree on the price of the instrument. It promotes more efficient stock market trading by allowing direct discussion and execution between traders by passing intermediaries. Cross trading, while not a new concept, has expanded because of technology such as electronic communication networks (ECNs), which allow traders to communicate directly.

This technique provides advantages such as faster execution times, lower costs, greater control, and increased privacy. However, it is crucial to note that most stock exchanges do not allow cross trading, save in rare circumstances where the buyer and seller use the same broker or asset management organization.

Real-world examples include Walmart’s acquisition of Flipkart and MasterCard’s investment.

Frequently Asked Questions (FAQs)