by Amanda Harvey
What is Front-Running Trading?
Front-running trading is simply trading that is conducted with the intent of being ahead of other market participants. Some types of front-running trading are illegal and involve trading by a broker or analyst using information gathered before it has been released to clients. Other forms of front-running trading are legal, but tend to be seen as unethical.
When is Front-Running Trading Illegal?
Illegal forms of front-running trading may breach laws which involve fraud, market manipulation or insider trading. These types of illegal trading come under the jurisdiction of the US Securities and Exchange Commission (SEC) which is a branch of the US Federal Government.
If a broker puts their own financial interests ahead of the financial interests of their customer, they are deemed to be committing fraud. An example of this would be that upon receiving an order to buy a large block of shares, the broker first buys a smaller amount of shares for themselves. Once the large order is placed, the price subsequently rises, and the broker is able to sell for an immediate profit.
Insider trading is a type of front-running trading conducted based on non-public information about the developments within a company which will affect the price of the company’s shares.
Market manipulation involves the creation of false or misleading misinformation which is done with the aim of affecting prices or movement in the market, which is then taken advantage of with the placing of trades.
Forms of Legal Front-Running Trading
Front-running trading is not illegal if it is based on public information. There are traders who practice front-running trading founded on the placing of a large order on the public market.
Some traders conducting front-running are simply adept at anticipating a move about to happen. This may be based on market analysis or simply observation of the behavior of another broker.
There are other front-running trading strategies that include techniques such as penny jumping. When a large order is placed with a ‘buy limit,’ which means maximum price that the trader is willing to pay, penny jumping is conducted by purchasing shares for a penny more than the limit on the order. The trader executing the penny jumping expects the price to rise, and if it does, they realize a profit. If the price does not rise, they will likely be able to sell their shares at the buy limit price, thereby only losing a penny per share.
Another form of front-running trading is based on the speed of technology -- being able to execute a trade seconds faster than other traders can then give the front-running trader the opportunity to immediately re-sell at a higher price.
With the goal of every stock market player being to make a profit, there will always be traders trying anything they can get away with to stay ahead of the game. Some of these methods of front-running trading may land the traders executing them in jail, other techniques may simply cause eyebrows to be raised, but as long as there is a stock market, there will always be front-running trading going on.