# Wash Trading Explained: Definition, Mechanism, and Real-World Examples

![Wash Trading](https://www.investopedia.com/thmb/ppb31HMqtvOPrBxjh1uWwOB24t4=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/washtrading.asp-final-8ed9e203720d4fd4925f15c2f07c5097.jpg)

*— Investopedia / Jake Shi*

## What Is Wash Trading?

Wash trading deceives market participants by artfully inflating trading volumes for [securities](https://www.investopedia.com/terms/s/security.asp). This illegal strategy involves the same trader buying and selling the security to portray false market activity. Whether through broker collusion or self-execution, such trades can mislead investors about a security’s popularity and price direction.

Wash trading tricks investors into thinking a security has higher trading [volumes](https://www.investopedia.com/terms/v/volume.asp), which could boost legitimate trading. Wash trading is illegal under U.S. law, and the [Internal Revenue Service (IRS)](https://www.investopedia.com/terms/i/irs.asp) bars taxpayers from deducting losses that result from wash trades from their taxable income.

### Key Takeaways

*   Wash trading is an illegal practice where traders buy and sell the same security to create false market signals.  
    
*   Regulations from bodies like the IRS and CFTC prohibit wash trading to prevent market manipulation and misleading information.  
    
*   High-frequency trading firms can exploit wash trading due to their technology, making regulatory enforcement challenging.  
    
*   Wash trading in cryptocurrencies inflates trading volumes and may be used in pump-and-dump schemes.  
    
*   The use of wash trading extends to various financial assets and has been involved in scandals like the LIBOR manipulation.

## How Wash Trading Operates and Its Implications

The federal government banned wash trading with the Commodity Exchange Act in 1936, requiring all commodity trading to happen on regulated exchanges. Before it was banned in the 1930s, stock [manipulators](https://www.investopedia.com/terms/m/manipulation.asp) used wash trading to falsely inflate stock prices for profit.

[Commodity Futures Trade Commission (CFTC)](https://www.investopedia.com/terms/c/cftc.asp) regulations also prohibit brokers from profiting from wash trades, even if they claim they weren't aware of the trader's intentions. Brokers therefore must perform due diligence on their customers to make sure that they are buying shares in a company for the purpose of common beneficial ownership.

The IRS bans losses from wash sales. A wash sale happens if you buy and sell a security within 30 days and incur a loss.

## The Intersection of Wash Trading and High-Frequency Trading

Wash trading made headlines in 2013 as [high-frequency trading](https://www.investopedia.com/terms/h/high-frequency-trading.asp) grew popular. High-frequency trading is the practice of using super fast computers and high-speed internet connections to perform upwards of tens of thousands of trades per second.

 In 2012, CFTC Commissioner Bart Chilton aimed to investigate high-frequency trading for potential wash trading law violations.

In 2014, the [Securities and Exchange Commission (SEC)](https://www.investopedia.com/terms/s/sec.asp) charged Wedbush Securities for failing "to maintain direct and exclusive control over settings in trading platforms used by its customers," a failure that enabled some of its high-frequency traders to engage in wash trades and other prohibited and manipulative behavior.

## The Role of Wash Trading in the Cryptocurrency Market

Recently, wash trading has also spread to [cryptocurrencies](https://www.investopedia.com/terms/c/cryptocurrency.asp). Many tokens struggle to stand out, leading to fake trading volume to seem popular. But even the most popular cryptocurrencies, including [Bitcoin](https://www.investopedia.com/terms/b/bitcoin.asp), experience wash trading.

A 2022 study of 157 cryptocurrency exchanges by Forbes found that over half of all reported Bitcoin trading volume is either fake or non-economic wash trading. Cryptocurrencies are prone to [pump-and-dump](https://www.investopedia.com/terms/p/pumpanddump.asp) schemes. Fake trading volumes and insider hype raise a token's value, letting holders sell at high profits.

There are multiple potential reasons for the prevalence of wash trading in the crypto space. Even major digital currencies like Bitcoin often lack universally accepted methods of calculating daily trading volume. This leads to cryptocurrency firms producing oftentimes wildly divergent figures for historical trading volumes. Cryptocurrency exchanges themselves often lack legitimacy, and there have been many high-profile public collapses of token exchanges in recent years. Extreme [volatility](https://www.investopedia.com/terms/v/volatility.asp) in the cryptocurrency space may incentivize rapid buys and sells. Finally, crypto's murky status with U.S. and other government regulators creates a further opportunity for misleading trade activity.

## Illustrative Cases of Wash Trading in Financial Markets

Wash trades are essentially [trades that cancel each other out](https://www.investopedia.com/terms/w/wash.asp) and have no commercial value as such. But they are used in a variety of trading situations.

For example, wash trades were used in the [LIBOR scandal](https://www.investopedia.com/terms/l/libor-scandal.asp) to pay off brokers who manipulated the [LIBOR](https://www.investopedia.com/terms/l/libor.asp) submission panels for the Japanese yen. According to charges filed by the U.K. financial authorities, UBS traders conducted nine wash trades with a brokerage firm to generate 170,000 pounds in fees as a reward to the firm for its role in manipulating LIBOR rates.

Wash trades can also be used to generate fake volumes for a stock and pump up its price. Suppose a trader XYZ and brokerage firm collude to buy and sell stock ABC rapidly. Noticing activity on the stock, other traders may put money into ABC to profit from its price movements. XYZ then shorts the stock, thereby profiting from its downward price movement.

## What Is Wash Trading?

Wash trading refers to an illegal activity in which a single trader buys and sells the same security in order to generate misleading market information. Wash trading is often performed to artificially inflate the trading volume of a security.

## What Is an Example of Wash Trading?

The IRS defines a wash sale as one that happens within 30 days of the purchase of the same security and generates a loss.

## Why Would Someone Do Wash Trading?

In some cases, wash trading bolsters the trading volume of a security, potentially inspiring more legitimate trade activity. Wash trading can also be used to help artificially boost the price of the security as part of a pump-and-dump scheme.

## The Bottom Line

Wash trading involves a trader illegally buying and selling the same security to provide misleading market information, inflate trading volumes, or manipulate security prices. This practice is particularly concerning in the high-frequency trading and cryptocurrency markets, where it can mislead investors by masking true trading volumes and price stability.

Federal regulations, including those from the IRS and CFTC, prohibit wash trading and enforce penalties to maintain market integrity. Awareness of these deceptive practices helps investors make informed decisions and avoid the influence of misleading trading activities.

> **Article Sources**
>
> 1.  Internal Revenue Service. "[Publication 550: Investment Income and Expenses](https://www.irs.gov/pub/irs-pdf/p550.pdf)," Page 56.
>     
> 2.  Commodity Futures Trading Commission. "[CFTC Glossary](https://www.cftc.gov/LearnAndProtect/EducationCenter/CFTCGlossary/glossary_wxyz.html#:~:text=Wash%20Trading%3A%20Entering%20into%2C%20or,Exchange%20Act%20prohibits%20wash%20trading.)."
>     
> 3.  Commodity Futures Trading Commission. "[History of the CFTC: US Futures Trading and Regulation Before the Creation of the CFTC](https://www.cftc.gov/About/HistoryoftheCFTC/history_precftc.html)."
>     
> 4.  Commodity Futures Trading Commission. "[Opening Statement of Commissioner Bart Chilton Before the CFTC Technology Advisory Committee Meeting](https://cftc.gov/PressRoom/SpeechesTestimony/chiltonstatement062012)."
>     
> 5.  Securities and Exchange Commission. "[SEC Announces Charges Against Wedbush Securities and Two Officials for Market Access Violations](https://www.sec.gov/news/press-release/2014-115)."
>     
> 6.  Forbes. "[More Than Half of All Bitcoin Trades Are Fake](https://www.forbes.com/sites/javierpaz/2022/08/26/more-than-half-of-all-bitcoin-trades-are-fake/?sh=58201f9d6681)."
>     
> 7.  Financial Services Authority. "[Final Notice](https://www.fca.org.uk/publication/final-notices/ubs.pdf)," Pages 1-4.