Manipulation of the foreign currency market is difficult. However, traders can still manipulate the value of a currency in order to earn a profit. It’s difficult to tell how much the market is worth on any one day because it’s a 24-hour market. Big companies like banks and hedge funds influence the market. Wash trading is one of the ways they influence the market. Manipulation of the FX market of a currency with fewer market players is easy. This is because other market players and regulators pay more attention to significant currencies and currencies with a large number of market participants.
What is wash trading?
Wash trading is a practice in which a trader buys and sells an asset only to provide the market with false information. Wash transactions are sometimes done by a conspiring trader and broker, while other times, wash trades are executed by individuals acting as both the buyer and seller.
Wash trade rule
The wash sale rule prevents an investor from claiming a tax deduction if they sell a loss-making investment then buy it, or one that is substantially similar, within 30 days after the sale.
Because it includes the day you sell your investment, it adds up to a total of 61 days during which you (or your spouse, or a business you control) are unable to purchase an investment that is the same or similar enough in the eyes of the IRS. Otherwise, your transaction can be labeled a wash sale, and you won’t be able to recover any of your losses.
This is meant to prevent bad faith investors from taking advantage of brief drops in the value of an investment to achieve a tax credit, then repurchasing the same investment to lock in a possibly superior cost basis on which all future gains taxes will be computed.
Reasons it’s done
- To give the appearance of artificial demand for a certain currency.
- To inflate the value of a currency by creating artificial demand.
- To boost public metrics intentionally.
- To acquire rewards that are worth more than the cost of attack.
Why is it a problem?
Wash trading has bad consequences for all parties involved, investors, collectors, traders, and the worldwide forex community. Below are the reasons for adverse outcomes.
- Projects no longer have meaningful data on the growth and reach of their own platform. Instead of focusing on their product, they should spend their time cleansing their own records to evaluate genuine vs. faked use. Workers on the project will also have to deal with unrealistic expectations and uninformed people.
- Investors are increasingly obliged to rely on verifiable facts, making due diligence considerably more challenging. They necessitate the use of professionals to examine the data for inconsistencies.
- Collectors and traders can’t make well-informed judgments. Due to false data and history, if a user likes a piece of art or collectible, they may spend too much, sell for too little, or otherwise make an ignorant judgment.
- Wash trading provides further ammo to regulators and proponents of traditional financial institutions in their fight against decentralization. The more we can adapt to societal standards (property rights, financial practices, marketing strategies), the more technology will be embraced and accepted.
What happens if you make a wash trade?
If you purposely or accidentally violate the wash sale rule, the IRS will not allow you to claim that loss on your taxes in the current or, if it’s substantial enough, subsequent years. If you expected that to balance your capital gains or lower your taxable income, you might find yourself owing more taxes than you anticipated. This can seriously hinder some people’s tax-loss collecting plans.
However, you may still get some benefits from your wash sale. You can multiply the amount of your loss by the cost of repurchasing the same or nearly comparable investment. This increases your cost basis, which might save you money on capital gains tax in the future—or allow you to claim a larger loss if you sell the investment at a loss in the future.
How can you avoid a wash trade?
Make an investment strategy
Investors who are unprepared for short-term market downturns may unintentionally trigger the wash sale rule by panic selling and then repurchasing the same investment after the market recovers. Having a long-term investment strategy that you stick to, even during market downturns, will assist you in making the best investment and tax decisions in both good and bad times.
Make a considerably distinct investment
While the IRS’s definition of “substantially equivalent” isn’t exact, the basic line is that the government doesn’t want you to obtain a tax deduction for something that isn’t actually a loss for you. If you sold JPY, selecting a different currency might be a good way to prevent a wash sale. Consider investing in a fund that covers the same or a related sector to the currency you sold.
To be extra cautious, investing in a completely new business or sector will ensure that you do not fall victim to the wash sale rule. It is recommended to work with a financial advisor or a tax specialist if you’re not sure how unique your alternative investment has to be. You might also use a robo-advisor to help you with your tax-loss harvesting.
Wait 30 days
The best strategy to avoid a wash sale is to wait the entire 30-day period after selling your investment before buying the same or a comparable investment. You’ll also want to make sure you didn’t acquire the same or a comparable investment on the day you sold or in the 30 days before. Some investors may go insane if their money sits on the sidelines for too long, so make sure you put it into something else.
Conclusion
A wash sale occurs when you sell a currency and then buy the same currency within 30 days after the transaction. It’s not difficult to prevent a wash sale, but if you’re a day trader, it’s easy to forget. Rather than adding up your losses and gains over the course of the year, it could be easier to just close out any positions you wish to declare a loss on and then not repurchase the asset for a full 30 days.