front running investment & finance definition
Illegally
making a trade for a personal account or a
preferred customer’s account with the advance knowledge that a large order is
in the market or will be coming to the market that likely will create a
profit. Front running is possible in situations in which traders in the futures
or stock markets trade both for their own accounts and their customers’
accounts, a practice known as duel trading. However, just because a trader
engages in dual trading doesn’t mean that the trader is involved with front
running.
See front running in Wall Street Words
Entering into a trade while taking advantage of advance knowledge of pending orders from other investors. For example, an exchange specialist may step in front and buy stock for slightly more than the price offered by other investors. The 2001 change to pricing stocks in pennies rather than fractions facilitated front running by reducing the extra amount that must be offered to step in front of other orders. Also called pennying, stepping in front.
Case Study The switch to pricing stocks in decimals rather than fractions brought narrower bid-ask spreads at the same time it raised new concerns about front running by specialists and market makers. With penny intervals in decimal pricing, market makers found it less expensive to step ahead of a large order. Suppose an institutional investor has placed a limit order to buy 50,000 shares of XYZ stock at $35.50. Knowledge of the limit order allows the exchange specialist or Nasdaq market maker to step ahead of the institutional order and offer $35.51 with little risk of incurring a big loss. In the event the stock price doesn't rise, the market maker can sell the stock for $35.50 to the institution that placed the limit order. On the other hand, a rise in the stock price produces a nice profit for the front-running market maker that offered minimal price improvement. Front running was considerably more expensive with fractional pricing, which resulted in price intervals of
1/
16 (6.25¢) to
1/
8 (12.5¢). Thus, decimalization benefited investors who profited from reduced spreads at the same time it increased the possibility that limit orders would not be executed.
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