How to detect wash trading?

Pure wash trades (see What is wash trading?) are easy to detect, as long as the trade surveillance system is able to know the identity of the persons who are making the transactions. Indeed, in such case, a simple alert for transactions within the same person (or colluding persons) will work.

However, detecting one transaction within the same person (or colluding persons) is definitive not material enough... It even could have happened by mistake... Therefore, in order to mitigate false positives, the trade surveillance system should trigger alerts only when a certain quantity of transactions within the same person (or colluding persons) occurs.

In addition, a key factor to understand is whether there was a manipulative intent (just like in other forms of market manipulation). Thus, after detecting a suspicious number of transactions within the same person (or colluding persons), one has to understand who that person is and what reason he/she may have had to allegedly place wash trades.

Likewise, the trade surveillance system could contain a list of the people that could have motives to place wash trades, including relevant shareholders and top/executive managers of the issuer (and eventually of the exchange as well), alongside with potential colluding partners. Detecting a considerable number of transactions executed on both sides by someone on this list constitutes a strong indication that they were indeed wash trades.

Camouflaged wash trades and quasi wash trades

Camouflaged wash trades and quasi wash trades (see What is wash trading?) are trickier to detect, as the trade surveillance system needs to be able to distinguish short-term trading from wash trading. Indeed, there is nothing wrong in buying and selling a security in the same or similar quantities, and at same or similar prices. The problem is when a person does it with the specific intent of impacting the market without prompting relevant changes in the beneficial interests and while having limited market risk.

Thus, the trade surveillance system should be able to detect situations in which a person buys (sells) and later sells (buy) a security:

• In the same or similar quantities;
• At the same or similar prices - incurring limited losses or limited gains; and
• Within relatively short time-intervals (up to a few days);

And should be set to trigger an alert if such transactions were performed with sufficiently enough quantities and with sufficiently enough frequency, specially if they were performed by any of the persons contained in the list I previously mentioned.