Front running

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This article is about the financial practice. For the practice as applied to domain names, see domain name front running.

Front running is the illegal practice of a stockbroker executing orders on a security for its own account while taking advantage of advance knowledge of pending orders from its customers. When orders previously submitted by its customers will predictably affect the price of the security, purchasing first for its own account gives the broker an unfair advantage, since it can expect to close out its position at a profit based on the new price level. The front running broker either buys for his own account (before filling customer buy orders that drive up the price), or sells (where the broker sells for its own account, before filling customer sell orders that drive down the price).[1]

In 2003, several hedge fund and mutual fund companies became embroiled in an illegal late trading scandal made public by a complaint against Bank of America brought by New York Attorney General Eliot Spitzer. A resulting U.S. Securities and Exchange Commission investigation into allegations of front-running activity implicated Edward D. Jones & Co., Inc., Goldman Sachs, Morgan Stanley, Strong Mutual Funds, Putnam Investments, Invesco, and Prudential Securities.[2]


For example, suppose a broker receives a market order from a customer to buy a large block—say, 400,000 shares—of some stock, but before placing the order for the customer, the broker buys 20,000 shares of the same stock for his own account at $100 per share, then afterward places the customer's order for 400,000 shares, driving the price up to $102 per share and allowing the broker to immediately sell his shares for, say, $101.75, generating a significant profit of $35,000 in just a short time. This $35,000 is likely to be just a part of the additional cost to the customer's purchase caused by the broker's self-dealing.

This example uses unusually large numbers to get the point across. In practice, computer trading splits up large orders into many smaller ones, making front-running more difficult to detect. Moreover, the U.S. Securities and Exchange Commission's 2001 change to pricing stock in pennies, rather than fractions of no less than 1/8 of a dollar, facilitated front running by reducing the extra amount that must be offered to step in front of other orders.

By front-running, the broker has put his or her own financial interest above (or in front of) the customer's interest and is thus committing fraud. In the United States, he or she might also be breaking laws on market manipulation or insider trading.

Brad Katsuyama is a financial services executive, working as the president, CEO and co-founder of the IEX, the Investors Exchange.[3] Katsuyama is also the focus of Flash Boys,[4][5][6] a non-fiction book by Michael Lewis [7] about high frequency trading (HFT) [8] in financial markets.[9] Brad Katsuyama led a team that implemented THOR, a securities' order-management system where large orders are split into many different sub-orders with each sub-order arriving at the same time to all the exchanges through the use of intentional delays.[10] All these events would happen in milliseconds not perceivable to humans but perceivable to supercomputers capable of noticing such events in microcosmic timeframes. He instead led a team that implemented the THOR (trading platform) where large orders are split into many different sub-orders with each sub-order arriving at the same time to all the exchanges through the use of intentional delays.[11][12][13] Thor was developed to split the order into smaller sub orders and then to slow down the speeed of the orders in a way that will allow all the orders to arive at all the different excahnges at the same exact time. The book Flash Boys, also goes into great detail in exposing Dark liquidity, Hot money and how HFT traders can front run orders placed by investors with over half of all trades by computers using Algorithmic trading.

In 2002, 85% of all stock market trading happened on the New York Stock Exchange and some human being processed every order.[14] The New York Times estimates that 50 percent to 70 percent of all trading in 2014 is done by “traders” who live in server parks by computers that run on Algorithm that executes trades in a fraction of the time that it takes to blink.[15] Algorithms that run on computers can trade stock at speeds 100 times faster than you can blink an eye, a $300,000,000 project used fiber optic cables that start from the Financial District in lower Manhattan and then all the way to Northern New Jersey where 13 public exchanges are located at the Bats Exchange.[16][17] This is the location of Direct Edge BATS Trading to be the third largest stock market in the United States, behind the New York Stock Exchange and NASDAQ.[18] Starting at the Chicago Mercantile Exchange,[19] the largest future exchange in the world is the location where Spread Networks started a 827 mile long fiber optic line all the way to the Bats Exchange in Nortern New Jersey.

A 827-mile direct route was built and shaved off three milliseconds, at a small cost of $300,000,000 plus maitence. Electronic trades are completed 100 times faster than the blink of an eye (a fraction of a millisecond)--this is the speed of front running, and with the faster connection, computers can play one order against other orders, noticing an order and buying it first. This is all in order for computers with the fastest connections to sniff out and Bait-and-switch orders with a slower internet connection. [20] slower trades and beat them to the exchange. [21] [22]

Other uses of the term[edit]

Front-running may also occur in the context of insider trading, as when those close to the CEO of a firm act through short sales ahead of the announcement of a sale of stock by the CEO, which will in turn trigger a drop in the stock's price. Khan & Lu (2008: 1) define front running as "trading by some parties in advance of large trades by other parties, in anticipation of profiting from the price movement that follows the large trade". They find evidence consistent with front-running through short sales ahead of large stock sales by CEOs on the New York Stock Exchange.

While front-running is illegal when a broker uses private information about a client's pending order, in principle it is not illegal if it is based on public information. In his book Trading & Exchanges, Larry Harris outlines several other related types of trading. Though all these types of trading may not be strictly illegal, he terms them "parasitic".

A third-party trader may find out the content of another broker's order and buy or sell in front of it in the same way that a self-dealing broker might. The third-party trader might find out about the trade directly from the broker or an employee of the brokerage firm in return for splitting the profits, in which case the front-running would be illegal. The trader might, however, only find out about the order by reading the broker's habits or tics, much in the same way that poker players can guess other players' cards. For very large market orders, simply exposing the order to the market, may cause traders to front-run as they seek to close out positions that may soon become unprofitable.

Large limit orders can be "front-run" by "order matching" or "penny jumping". For example if a buy limit order for 100,000 shares for $1.00 is announced to the market, many traders may seek to buy for $1.01. If the market price increases after their purchases, they will get the full amount of the price increase. However, if the market price decreases, they will likely be able to sell to the limit order trader, for only a one cent loss. This type of trading is probably not illegal, and in any case, a law against it would be very difficult to enforce.[23]

Other types of traders who use generally similar strategies are labelled "order anticipators." These include "sentiment-oriented technical traders," traders who buy during an asset bubble even though they know the asset is overpriced, and squeezers who drive up prices by threatening to corner the market. Squeezers would likely be guilty of market manipulation, but the other two types of order anticipators would not be violating any US law.[23]

"Front running" is sometimes used informally for a broker's tactics related to trading on proprietary information before its clients have been given the information.

For example, analysts and brokers who buy shares in a company just before the brokerage firm is about to recommend the stock as a strong buy, are practising this type of "front running". Brokers have been convicted of securities laws violations in the United States for such behavior. In 1985, a writer for the Wall Street Journal, R. Foster Winans, tipped off brokers about the content of his column Heard on the Street, which based upon publicly available information would be written in such a way as to give either good or bad news about various stocks. The tipped off brokers traded on the information. Winans and the brokers were prosecuted by the prosecutor Rudolph Giuliani, tried and convicted of securities fraud. Their convictions were upheld by the United States Supreme Court in 1986.[24]

One common practice of high-frequency traders (HFT) is a form of front running, where they peer into various exchanges and try to detect orders as they propagate from a broker's order router. HFT traders place many small orders that indicate buying/selling pressure. Those with the shortest lag in reaching other exchanges then place orders on those exchanges to catch the rest of the order, at a more advantageous price.[25] According to Harvard Political Review writer Austin Tymins, HFT firm Citadel LLC made billions of dollars front-running the trades of large institutional investors, many of which are investing on behalf of middle-class clients.[26][27]

See also[edit]


  1. ^ "Front-running; an Unethical Behavior". SEC. Retrieved 25 July 2014. 
  2. ^ Benjamin, Jeff (September 8, 2013). "Image Repair: Mutual funds still recovering 10 years after scandal". [Investment News]. 
  3. ^ "IEX Group - About Us | A Market That Works For Investors". Retrieved 2014-04-03. 
  4. ^ Massoudi, Arash; Tracy Alloway (March 28, 2014). "'Flash Boys' starts Wall St soul searching". Financial Times. Retrieved March 31, 2014. 
  5. ^ "Michael Lewis 60 Minutes Interview on HFT [VIDEO]". Value Walk. Retrieved March 31, 2014. 
  6. ^ Lewis, Michael (2014). Flash Boys: Cracking the Money Code. London, UK: Allen Lane. ISBN 9780241003633. 
  7. ^ Simon & Schuster /Michael-Lewis authors page
  8. ^ Times Topics: High-Frequency Trading, The New York Times, December 20, 2012
  9. ^ "The New York Times". Retrieved 2014-04-11. 
  10. ^ "Trading chief exits RBC - Financial News". 2012-09-19. Retrieved 2014-04-03. 
  11. ^ "Trading chief exits RBC - Financial News". Retrieved 2014-04-05. 
  12. ^ Weil, Jonathan (April 1, 2014). "Weil on Finance: FBI Hops on Michael Lewis Bandwagon". Bloomberg News. Retrieved April 1, 2014. 
  13. ^ Bradford, Harry (April 1, 2014). "FBI Investigating High-Frequency Traders: WSJ". Huffington Post. Retrieved April 1, 2014. 
  14. ^ Flash Boys p. 35, 35
  15. ^ The New York Times estimates that 50 percent to 70 percent of all trading in 2014 is done by “traders” who live in server parks by computers that run on Algorithm that executes trades in a fraction of the time that it takes to blink.
  16. ^ class action law suit Bats Exchange, Inc violated contract HFT, side deals, pre
  17. ^
  18. ^ "Direct Edge Says IPO Possible After Exchange Status". Bloomberg Businessweek. 21 July 2010. 
  19. ^ "". Retrieved 2012-09-22. 
  20. ^ The Wall Street Journal
  21. ^ CBS News
  22. ^ Wired (magazine)
  23. ^ a b Harris, Larry (24 October 2002). Trading and Exchanges (First ed.). New York: Oxford University Press. ISBN 0-19-514470-8. 
  24. ^ * Carpenter v. United States, Supreme Court decision
  25. ^ Kroft, Steve (March 30, 2014). "Is the U.S. stock market rigged?". CBS News. Retrieved November 2, 2014. 
  26. ^ Tymins, Austin (September 30, 2014). "The Rigged Market: A Review of Flash Boys". Harvard Political Review. Retrieved October 30, 2014. 
  27. ^ The Wolf Hunters of Wall Street An Adaptation From ‘Flash Boys: A Wall Street Revolt,’ by Michael Lewis, New York Times


  • Harris, Larry (2003). "Order Anticipators". Trading & Exchanges. Oxford: Oxford Press. 
  • Khan, Mozaffar; Lu, Hai (August 1, 2008). "Do Short Sellers Front-Run Insider Sales?". MIT Sloan Research Paper No. 4706-08. SSRN 1140694. 

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