For more than a century, developmental psychologists have been studying how and why children play. One of the most widely accepted schools of thought describes children progressing through three stages of play: solitary, or playing by themselves; parallel, or playing near other children, but not necessarily with them; and group play, where the children are clearly interacting with each other. The speed at which children pass through these stages is highly variable, depending on such factors as the child's personality, the number of siblings in her household, or her exposure to other children. Most children are not capable of true group play until well into their preschool years.
Parents often wonder about sex play between kids. There are certain issues that differ with the ages of children, for example touching between 2-year-olds is very different than touching between 12-year-olds, but there is one universal indication for your concern: if coercion of any kind was used by either child to gain compliance from the other, adult intervention is imperative. There is also one universal rule for parental reaction: regardless of what you see, stay calm and think before you say anything to your child or another parent. If you display a shocked exclamation or scream, this can stay with the children involved long after any memory of the activities that caused this reaction.
Recognizing the harmlessness of parallel play with or without clothes, many families allow full nudity among their kids, for example bathing the younger kids all together. A child will let you know when she's outgrown this and then you must heed your child's request and honor a request for privacy from siblings.
Toddlers who are still in the solitary or parallel phase of development would be highly unlikely to be interested in a game like naked doctor or you-show-me-yours-and-I'll-show-you-mine. Toddlers may glance at one another or maybe even reach out in curiosity to touch another child's genitals, but this behavior should be treated like your child reaching out and annoying someone with an unwanted touch anywhere.
It is not uncommon for an older child to decide that he or she is curious and wants to inspect a younger child and the younger child may not mind at all. This seems to have been the case in the family of actor/writer Lena Dunham. Although some pundits labeled her a sex offender when her memoir revealed that she'd inspected her little sister's genitalia, it apparently was a non-event for her sister. Parents who come into this situation might calmly announce that playtime is over and then speak with each child in private. That conversation should be a lesson in respecting the personal boundaries of others, and offering to answer their questions about body parts. Doing this without shaming the children is crucial. It's key to determine if either child used any kind of force or coercion; if one child appears frightened of the other pay close attention. Speak to the child who may have done the coercing and try to determine the motivation and where they came up with the idea.
If the answers indicate that someone else has been playing this 'game' with them, you need to investigate further of call authorities. If they truly can't understand that their behaviors may cause pain to another, it may be time to seek the support of a qualified child development specialist. While the overwhelming mutual majorly of sexual exploration between children is harmless, learning to identify and intervene where maladaptive behaviors are indicated is one of the best things a parent can do for their child; intervention with young people has a very high probability of success.
Rosenzweig is also author of The Sex-Wise Parent: The Parents Guide to Protecting Your Child, Strengthening Your Family and Talking to Kids about Sex, Abuse and Bullying. For more information, read her blog and follow @JanetRosenzweig on Twitter.