Circular trading

Circular trading is a fraudulent trading practice in which a group of market participants—usually brokers, traders, or related companies—buy and sell the same securities or goods among themselves in a circular pattern to create an illusion of high trading volume or inflated market prices. Although no real change in ownership or economic value occurs, this manipulation can mislead investors, distort market prices, and artificially boost a company’s financial position. Circular trading is considered illegal under securities and taxation laws in most jurisdictions.

Nature and mechanism

In circular trading, the same asset is transferred repeatedly through a chain of transactions among a closed group of participants. Each entity buys and sells the asset in turn, giving the impression of active trading. The circular flow eventually returns the asset to the original owner, completing a “loop”.
For example, Company A sells shares to Company B, which sells them to Company C, and then Company C sells them back to Company A. On paper, these appear as genuine trades, generating high turnover and price movement, but in reality, no real transfer of risk or ownership takes place.
Circular trading can occur both in financial markets (involving shares, bonds, or derivatives) and in goods and services markets (to manipulate tax credits or invoices).

Objectives of circular trading

Circular trading is carried out for a variety of deceptive purposes:

• Price manipulation: To create an illusion of demand and drive up the price of a security or commodity.
• Inflated turnover: To show artificially high sales and revenue in company accounts, improving financial ratios or attracting investors.
• Tax evasion: To generate false invoices for claiming input tax credits under systems like VAT or GST.
• Money laundering: To channel illicit funds through multiple accounts and disguise the origin of money.
• Market influence: To manipulate investor perception by simulating active market interest in certain shares or products.

Circular trading in the stock market

In securities markets, circular trading is a form of market manipulation prohibited by financial regulators. It is typically executed through collusion between brokers and traders. The process often involves:

1. Coordinated buying and selling of the same shares among related accounts.
2. Artificially boosting trade volumes to attract unsuspecting retail investors.
3. Causing price volatility to benefit insiders who later sell shares at inflated prices (a “pump-and-dump” variant).

Such trades may technically appear legitimate because transactions occur through recognised exchanges, but their underlying intent—deception—violates securities law. Regulators such as the Securities and Exchange Board of India (SEBI) and the Financial Conduct Authority (FCA) treat circular trading as a serious offence.

Circular trading in taxation

Circular trading is also common in the context of indirect taxation systems, particularly those that allow input tax credits. Here, traders create fictitious sales and purchases by issuing fake invoices to each other in a circular chain. Each participant claims tax credits on purchases without paying actual tax on sales.
For instance, Company A issues an invoice to Company B, B to C, and C back to A. No actual goods are transferred, but each company claims tax credits, reducing tax liability. This form of circular trading causes significant losses to government revenue and is treated as tax fraud.

Indicators and detection

Regulatory and auditing bodies use various indicators to detect circular trading. Common red flags include:

• Repetitive trading of the same securities or goods among a small, closed group.
• Unusual spikes in trading volume without corresponding changes in fundamentals.
• Identical invoice values or quantities recurring across multiple entities.
• Round-tripping transactions with no net movement of funds or ownership.
• Sudden rise in turnover in financial statements without proportional increase in assets or profits.

Technological tools such as data analytics, network mapping, and transaction tracing are increasingly used to uncover patterns of circular trading in financial and tax systems.

Legal implications and penalties

Circular trading violates multiple provisions of law, including securities, company, and taxation regulations. Offenders may face:

• Monetary penalties: Heavy fines imposed by regulators.
• Suspension or revocation of licences: Brokers or companies found guilty may lose trading rights.
• Criminal prosecution: In severe cases involving fraud or money laundering, imprisonment may follow.
• Disqualification of directors or auditors: Individuals involved in approving or overlooking such trades may face professional sanctions.