A cross trade is a practice where a trade that is bought and sold for the asset is offset without recording this transaction on the exchange. Most exchange platforms do not permit cross trading. A cross trade can be legally executed when a broker matches a buy and sell for the same security for two separate client accounts and then reports them as a “cross trade” on the respective  exchange.

Cross Trade Example

Now that the cross trade definition is clear, let’s look at an example. Suppose a client wants to sell a certain security while another wants to buy it. A broker can easily match both those orders without sending the orders back to the stock exchange to be filled. Instead, both orders can be filled as a cross trade, and the transactions can be reported in a timely manner such that they are time-stamped with both the time of the trade and the price of the trades on both sides. To be legal, this cross-trade must be executed at the price point that corresponds with the security’s market price at that time.

When are Cross Trades Permitted?

Typically, cross trades are not permitted on major stock exchanges as orders need to be directly sent to the exchange so that the trade can be recorded. However, in select situations, cross trades can be permitted. Such is the case when both the seller and buyer are managed by the same asset manager. Another time in which a cross trade may be permitted is when the price of it is considered as competitive at the time of the trade being carried out.

A portfolio manager can – without difficulty – move one of the client’s assets to another that wants it so they can eliminate the spread of the trade. Both the manager and the broker must prove a fair market price for the transaction and then record the trade as a “cross trade” so they follow the legally correct regulatory classification. The asset manager is required to show the exchange involved that the cross trade was beneficial to both parties.

Certain other conditionals for cross trades to be permitted as the following:

– When the broker is transferring assets of clients between accounts they need not report this transaction on any exchange.

– Cross trades are also permitted for hedging derivative trades

– Finally, one can carry out cross trading for certain block orders.

Who is Cross Trading For?

Now that we understand what is cross trade meant for, who is the ideal candidate for it? While it isn’t necessary for investors involved in cross-trade to specify a price for the transaction to proceed, the only way an order can be matched by a broker is when she receives both a buy and sell order from two different investors who list the same trade price.

Depending upon the regulations of the exchange, or SEBI, such trades may be permitted, as each investor has shown an interest in carrying out a transaction at a specific price point. Hence, this type of trade may be more relevant to investors who trade securities that are highly volatile. This is because the value of the security may dramatically shift in a short time.

Pitfalls of Cross Trading

There are some inherent pitfalls when it comes to cross trading. The main reason they become problematic is due to a lack of proper reporting. When a trade does not get recorded through the exchange, either or both clients may not be able to buy or sell at the prevailing market price which is available to non-cross trade traders. As cross-trade orders are, by definition, never publicly listed, investors may not become aware as to whether a better price is available.

Another reason cross trading is considered controversial is that they potentially undermine the trust in a market. Some cross trades are technically considered legal, even while other market participants are not given the change to interact in these orders. Market participants may have wanted to take part in some of these orders, but were not given the opportunity to since the trade occurred off of the publicly listed exchange, making the transaction somewhat unfair.

A final concern is that multiple cross trades can be used to give the illusion substantial trading activity around security which can eventually influence its price. This is called ‘painting the tape’: a manipulative tactic to affect the market price of a certain security via illegitimate means.

Conclusion

Cross trading has a negative connotation when not carried out properly, but can be very helpful for investors looking to trade highly volatile securities. It’s important to use cross trading responsibly by knowing the cases in which it is appropriate and without legal consequences.