What is a Cross Trade?

A cross trade is an investment strategy where a single broker executes an order to buy and an order to sell the same security at the same time. This often involves a seller and a buyer who are both clients of the same broker, although the cross trade strategy can involve one investor who is not a regular client of the broker. Depending on the regulations that govern the stock exchange where the securities are traded, this type of trading may not be allowed. Even in settings where the cross trade is considered an acceptable practice, there are usually some limitations on its use.

One of the issues that many financial experts have with the cross trade is that the broker may choose to not make the trades on the exchange. Instead, the broker may use the order to buy to offset the order to sell, effectively creating an exchange between the two clients. This opens the door for one or both parties to not receive the best price for either portion of the dual transaction, a fact that causes many investors and brokerage houses to refrain from engaging in this type of activity.

Due to the potential pitfalls of this type of transaction, many regulatory agencies have established rules that apply to when and how the cross trade may be used. In the United States, a broker must be prepared to present evidence to the Securities and Exchange Commission on why this type of transaction took place, and what benefit both parties received from the deal. Unless both investors received some benefit from the transaction, there is a good chance that the activity does not comply with the regulations put in place by the SEC.

A similar practice to the cross trade is known as matching orders. This is a situation where a broker has received an order to buy shares of a certain stock at a specific price, while also receiving an order from a different customer to sell that same stock at the same price. In some nations, the broker can simply match the two, effectively creating a swap between the two customers that allows each investor to receive what he or she desired from the transaction. In other settings, the broker must actually appear on the exchange floor, declare the intention to purchase the shares at the desired price, and ask if there is any objection. If not, then the broker proceeds to buy the shares, then offers them for the same price to the client. The broker benefits by charging transaction fees, and the two investors benefit from the quick execution of their orders.