Wash Trade Definition - market abuse

Question

I am a bit new to trading and hope that I am making this post in the appropriate place to ask. I saw a few questions on wash trading but I am still a bit confused on the specifics (I describe a specific use case below)

I have been mostly day-trading, looking for volatile assets that I can see big profits in a short time period. I have also been doing some reading on different forms of market manipulation to make sure I'm not doing something wrong. While most of these (like pump-and-dump) are relatively hard to accidentally do, there were a few practices which I had some questions on.

The first one I was wondering about is wash trading. I can definitely understand how wash trading where you buy and sell to/from yourself at same price is bad since this artificially creates volume without changing ownership. However, what if the buy and sell limits are different? For example, suppose an imaginary asset is at $10.50. I expect this asset to simultaneously go down to $10 and up to $11 within the same hour. In this scenario, the goal would be to profit from its volatility. Is this acceptable to have both orders open at the same time or is this still considered wash trading?, Furthermore, what if after it sells at 11, I double my buy order at 10? Is this a good (and more importantly legal) trading strategy? I am having a difficult time finding a solid explanation of the differences between illegal wash trading and perfectly valid day trading and am a bit nervous to continue without understanding this point.

Answer 1

Confusingly there is both a US tax system rule named "wash trading" and also a market abuse typology with the same name. What you are describing is not the market abuse typology and so is not illegal but will have tax consequences around the treatment of losses.

The market abuse offence of wash trading involves placing a resting order on one side of the order book and then immediately entering an order on the other side which will aggress that resting order causing you to match your resting order. Clearly this is only possible to intentionally do this consistently in relatively illiquid markets where you run less risk of another participant trading with you. This is done both to inflate volume expectations in illiquid instruments and as a way of money laundering so it is taken very seriously by authorities and compliance teams.

Professional traders wash trade quite commonly by accident, the above said, and as long as you aren't intending your orders to match with each other you aren't likely to be investigated for this.

To answer some of your other questions and to add a little colour, if you expect the price to move to either $10 or $11 and then continue in that direction such that you will make a profit your bid ($10) and ask ($11) orders don't cross each other and so will not trade with each other. This means that you won't wash the lots. If you are entering limit orders on both sides of the book like this you are effectively providing liquidity in the same way that a market maker does. This can be very profitable for market makers because they generally receive fees for providing liquidity but it may well not be profitable if you are not receiving these. Some exchanges do provide what are called "maker fees" to retail traders but I'm not sure how much you personally can profit from them.

You also ask "Furthermore, what if after it sells at 11, I double my buy order at 10?" which obviously can't fit the typology of wash trading for market abuse as you no longer have 2 orders on the book which can match with each other.

The FCA have a relatively good worked and real world example: https://www.fca.org.uk/news/press-releases/fca-fines-and-prohibits-trader-market-abuse#:~:text=Wash%20trading%20is%20a%20form,'

Answer 2

Wash trading is where a trader(s) simultaneously buy and sell same security in order to pump up trading volume in order to create the illusion that the security is in play (trading activity). This is market manipulation and it is illegal. This is not to be confused with a wash sale violation.

As for your example of XYZ at $10.50 with a trading range of $10 to $11, there is nothing wrong with simultaneously placing an order to buy at $10 and another one to sell at $11. This provides liquidity and since the orders are placed at different prices, it is not wash trading. I've done this many times, particularly where I own the shares and would be happy to sell at the higher price and add to my position at the lower price. The likelihood of a fill is low, unless it's a volatile market.