What is 'Cross Trade'

Cross trade is a practice where buy and sell orders for the same stock are offset without recording the trade on the exchange, an activity that is not permitted on most major stock exchanges. This also occurs when a broker executes both a buy and a sell for the same security from one client account to another where both accounts are managed by the same portfolio manager.

BREAKING DOWN 'Cross Trade'

The lack of proper reporting involved in a cross trade opens up investors to potential risks regarding the financial outcome of the transaction. When the trade doesn't get recorded through the exchange, there is an associated risk that one or both clients did not get the best price based the current fair market pricing of the stock on the open market. Since the orders are never listed publicly, the investors may not be made aware as to whether a better price may have been available.

However, cross trades are permitted in very selective situations, such as when both the buyer and the seller are clients of the same asset manager and the prices are considered to be competitive at the time of the execution of the trade.

Permitted Cross Trades

The portfolio manager can effectively swap out a bond or other fixed income product from one client to another and eliminate the spreads on both the bid and ask side of the trade. The broker and manager must prove a fair market price for the transaction and record the trade as a cross for proper regulatory classification. Before executing a cross trade, the asset manager must be able to prove to the Securities and Exchange Commission (SEC) that the trade was beneficial to both parties.

Cross Trades and Matching Orders

While a cross trade does not require each investor to specify a price for the transaction to proceed, matching orders occur when a broker receives a buying and selling order from two different investors, both listing the same price. Depending on local regulations, trades of this nature may be executable, since each investor has expressed an interest at completing a transaction at the specified price point. This may be more relevant for investors involved in the trading of highly volatile securities where the value may shift dramatically in a short period of time.

In other cases, the trade must be announced on the floor before it can be executed to provide those outside of the transaction an opportunity to object. Objections may arise if another broker has a request that should be given priority based on when the order was placed.

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