Which of the following is an implication of wash trading?

Which of the following is an implication of wash trading?

• A. It can lead to legal repercussions for the trader.
• B. It ensures a fair market price for a security.
• C. It is a common practice among professional traders.
• D. It enhances liquidity in the market.

Answer: (A)

Wash trading is a form of market manipulation where a trader simultaneously buys and sells the same financial instruments to create misleading activity in the market. This practice is illegal in many jurisdictions, as it distorts the genuine supply and demand for a security, impacting the market’s overall integrity.

Choosing the implication that it can lead to legal repercussions for the trader is correct because regulatory bodies closely monitor trading activities for signs of manipulation like wash trading. If caught, a trader could face severe penalties, including fines, bans from trading, or even criminal charges. Such enforcement of laws emphasizes the seriousness of maintaining fair trading practices and market integrity.

The other choices reflect misunderstandings of market dynamics. It is not true that wash trading ensures a fair market price; in fact, it does the opposite by misleading other market participants. Furthermore, while some traders may engage in wash trading, it is not a common practice among reputable professionals, who prioritize ethical standards. Lastly, while wash trading may create the illusion of increased activity, it does not contribute to legitimate market liquidity. Real liquidity derives from genuine trading activity by a diverse range of market participants.