A cross is the simultaneous buying and selling of the same security without recording the trade on a public exchange.
Understanding cross trades
A cross trade occurs when a broker matches a buy order and a sell order for the same asset across different client accounts. Instead of routing the orders to an open market like the London Stock Exchange or the Tokyo Stock Exchange, the broker executes the trade internally. Institutional investors, such as pension funds and asset management firms, are the primary entities that use this method.
The main reason for executing a cross trade is to avoid market impact and reduce transaction costs. When large blocks of shares are traded on an open exchange, the sudden increase in supply or demand can cause the price of the security to move unfavorably. By matching the orders internally, the broker executes the trade at the current market price without shifting the bid-ask spread. Clients save money because the broker charges a lower commission for an internal match compared to public market fees.
Financial regulators across different global jurisdictions heavily monitor cross trades. Regulators require brokers to prove that the execution price was fair to both the buyer and the seller. In many countries, brokers must report the cross trade to the relevant exchange or regulatory body shortly after execution to maintain market transparency. If a broker favors one client over another during the price matching process, it violates fiduciary duty laws.
Example
Suppose two large institutional Elephants are clients of the same brokerage firm. The first Elephant manages a retirement fund and wants to sell 500,000 shares of Global Peanut Corp. At the exact same time, the second Elephant manages a mutual fund at the same brokerage and wants to buy 500,000 shares of Global Peanut Corp. If the broker sends these orders to a public stock exchange, selling half a million shares might drive the stock price down before the trade finishes. To prevent this, the broker crosses the trade internally. The broker checks the current market price, which is $10 per share. The broker transfers the shares from the first Elephant to the second Elephant at exactly $10 per share. Both Elephants avoid paying the public exchange fees and the share price of Global Peanut Corp remains unaffected by the large transaction volume.