Understanding cross trade- What it is, its advantages, with examples (2024)

Introduction

With trading becoming widely popular, cross trading has become a hotly debated topic. Cross trade simply means a method where you buy or sell the same stock without going through the regular public trading process on the exchange market. Instead, it’s done privately, off the main trading platform.

Now, before you start thinking this method might be free for everyone, know that most exchanges don’t allow cross asset trading. However, under certain conditions and strict regulations, it is allowed legally.

But why does this matter? Well, cross trading plays a significant role in how exchanges and investors operate. It’s not just a random practice; there are reasons why it exists. With this blog, let’s dig deeper into what cross trade is and why it is important.

What is cross trade?

Cross trade happens when a trade for a particular asset is matched and settled between two investors without being recorded on the official exchange platform. Most stock exchanges don’t allow this legally. However, it can only be done legally by a stockbroker who matches the buy and sell orders of the same security from two or more different clients and classifies it as a “cross trade.”

Another variant of this is the opening and closing crosses. These are facilitated by exchanges like NASDAQ which collect data of all buy and sell orders made at the beginning and end of trading sessions.

It’s important not to mix up cross trading with other types of trades, like cross border trade or cross trade shipment. Cross trading in finance is all about matching buy and sell orders without recording them on the exchange. In contrast, other types of cross trade usually refer to international trade or shipping goods across borders.

Another concept similar to cross trade is cross commodity trading, also called commodity hedging. In cross hedging, investors usually use two related assets to reduce their overall future risk. For example, a coffee shop might hedge(reduce risk) against rising coffee prices by buying futures contracts for coffee beans. This strategy ensures that they still stay in profit, even if the prices go up.

Cross trade example

Let’s look at an example of cross trade to understand it better. Imagine a client wants to sell a stock, and another client wants to buy the same stock. Instead of sending these orders to the stock exchange to facilitate the trade, investors go through a broker who helps you to match with the investor directly.

Both orders are then filled and executed as a cross trade. It’s important that this happens at the current market price and is reported with the time and price as exhibited in the stock exchange. Ensuring this helps keep things legal and transparent.

When is cross trade permitted?

Cross trades are usually not permitted on big stock exchanges because orders must go directly to the exchange for record purposes. However, in specific cases, they might be permitted. Since cross asset trading happens unofficially and off the exchange, it can get risky due to excess misconduct and external manipulation.

Many exchanges avoid allowing cross commodity trading due to local rules and the risk of legal trouble if it’s not done right. But if it’s executed properly following the law, it’s permitted and ensures equal exchange between investing parties.

Cross trade is permitted under certain situations-

1. When both the seller and buyer are under the management of the same asset manager.
2. When the price of the trade is competitive to the exchange price at the time of execution.
3. When a portfolio manager can easily transfer assets between clients to eliminate trade spread.
4. When transferring assets between client accounts by a broker doesn’t require reporting to the exchange.
5. Certain block orders can also be executed through cross trading.

In each case, the broker and manager must ensure a fair market price, record the trade as a “cross trade”, and demonstrate its benefits to both parties, typically to the Securities and Exchange Commission (SEC).

Advantages of cross trade

1. Cost-Effectiveness

Cross trade lets traders improve their entry price by buying or selling assets at specific prices, bypassing the public order book. It also saves money by eliminating brokerage fees, even though it may take time for orders to match.

2. Faster Transactions

Cross asset trading leads to quicker trade agreements because traders can immediately match buy and sell orders for the same asset.

3. Increased Liquidity

Cross trade helps investors to post orders to buy at certain opening prices or during order imbalances, thus improving liquidity and reducing disruptions in the market.

4. Handling Block Orders

Cross trades help execute large block orders by matching buy and sell orders without recording their transactions on the exchange. This helps minimise market impact and allows for a better-negotiated price without alerting other traders about it.

Drawbacks of cross trade

1. Lack of proper reporting

As cross trade isn’t recorded on the exchange, clients may miss out on buying or selling at the best market price available to non-cross traders. Since these trades aren’t publicly listed, investors may not know if there’s a better deal somewhere else.

2. Undermining trust in the market

Cross community trading can make the market seem unfair because some participants can engage in these trades while others can’t. This undermines trust and fairness in the market because not everyone gets the same opportunities while cross trading.

3. Painting the tape

Many investors deliberately create multiple cross trades to generate a false illusion of high trading activity in the market. This directly influences the stock’s price unfairly. This manipulative tactic, known as “painting the tape,” can sometimes deceive genuine investors and distort market prices.

4. Non-Transparent Method

Unlike regular orders, cross trading doesn’t allow traders to set stop-losses or take-profit orders to protect their investments from dips or gain high profits. This lack of transparency is often exploited for malicious purposes, like manipulating prices and stock volumes to fool other investors. Additionally, as cross-trading is only available to certain investors, it often excludes others from accessing potentially better trading opportunities.

Conclusion

Cross trade involves matching buy and sell orders without recording them on the exchange. Ultimately, it’s up to investors to look at both sides, the pros and cons of cross trade and then decide whether to engage in cross trading or not. To learn more about such concepts, stay tuned to StockGro.

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