Circular trading

In the most common form of circular trading, groups of investors fraudulently inflate the share price of a company, then sell the shares they own for a profit. Less frequently, circular trading is used to directly impact a company's success or failure. In some cases, shareholders set thresholds for the price of shares at which they will stay invested within a company or leave it or set a price threshold at which they will decide to purchase more shares. Shareholders tend to follow the decisions of those around them; consequently, the departure of a small number of influential shareholders may pose a risk to the overall health of the company. When these thresholds have become reasonably well defined, circular traders may manipulate the stock prices to always stay on the side of the price threshold which is in their best interests, regardless of the real value of the shares. When instances of circular trading are discovered, changes in consumer confidence often spread through the entirety of the stock market, and public trust in the stock markets as a whole is eroded. == Examples ==

Circular trading has been most prevalent in India, with the majority of high-profile cases originating in the Indian stock market. The first case to receive public attention was that of Ketan Parekh, a stockbroker who was found guilty of a major stock market scam dating back to 1999. This was largely based on circular trading, although insider trading was also a significant component. There were seven companies acting in union to illegally manipulate the market. They illegally bought shares in companies leading up to the date of their IPO's, effectively driving the share value up, before offloading the shares directly after the IPO, artificially inflating a company's value so as to mislead investors about the value and popularity of particular IPOs. When the scam was discovered, Parekh was barred from acting within the Indian stock exchange until the year 2017. The case of Parekh has gained notoriety because he was found violating the ban on his involvement in the Indian stock exchange. A 2012 report found that Parekh was not only still active in the Indian Stock Exchange, but he was also continually engaging in serious violations of the law, including insider trading and circular trading. They were barred from buying, selling and dealing in securities on the market and had their bank accounts frozen. This was in response to proof that these individuals had created an artificially high volume in the market through synchronised trading among themselves. Numerous large companies that were well known in India were targeted—Marvens Biotech, Rasi Electrodes, Sat Industries, KSL & Industries, Asian Star Co, Allcargo Global Logistics, Panoramic Universal, and Ushdev International. This case created a large scandal in India because the use of circular trading caused investors to lose faith in the accuracy of share prices on the Indian stock market, which affects many more companies than just those specifically targeted. Following this, in 2012, SEBI imposed a penalty of 200,000 Indian Rupees on the brokers involved. == Responses ==

Methods for preventing circular trading have been in development since the outbreak of high-profile cases in India, starting in 2010. In India, SEBI has begun using several methods aimed at preventing this fraudulent practice. This is done through increasing regulation on the stock market in a way that restricts trading high volumes of stocks in short amounts of time. In 2018, Ramin Salahshoor published a paper demonstrating success in detecting circular trading using a network-based approach, based on data from the Iran Mercantile Exchange. This was achieved by constructing networks of daily trades by several separate traders, then analysing trade cycles of various lengths from these networks. Salahshoor was able to group traders from each day into groups of traders who were engaged in suspicious cycles that were indicators of circular trading and traders who were acting legitimately. This was possible because of the nature of herding in stock markets. Salahshoor noted that when the circular traders inflated the share price, they were effectively herding a larger number of legitimate investors into also buying these shares. By analysing which investors were commonly the instigators of this herd mentality, Salahshoor was able to identify which traders were acting illegitimately. Salahshoor also factored in price fluctuations over time so that randomly generated suspicious cycles were eliminated from the analysis. Prior to this breakthrough, circular trading was only detectable through initial guesswork and intuition based on discrepancies between the level of trade volume recorded and what should be expected, as well as rapid changes in trade volume that did not have any obvious cause in the real-world situation. Salahshoor's method has had success in identifying circular traders in Iran. Further research in this area may lead to methods that will allow for the increasingly swift and accurate identification of circular traders in various types of markets. This is particularly important, considering that circular traders are only ever brought to justice after significant market damage has already occurred. == References ==