Front-Running

Reviewed by Sujaini | Updated on Sep 28, 2020

Introduction

Front-running is when a broker or an investor joins a trade because they have foreknowledge of a large confidential deal which will impact the asset's price. Front-running is also known as forward-trading or tailgating. It can happen when stockbrokers know their firm plans to buy several shares of a particular stock and buy shares from the same stock on their own. It also occurs when an analyst or a broker buys or sells shares from their personal account before their firms buy or sell customers recommendations.

Front-running is illegal and unethical because it leverages private information that is not publicly available. Stockbrokers and traders frequently have access to inside information concerning their firm's investment plans. Brokers and traders may use this confidential information to make investments that will be of personal benefit to them. Buying when indexes or funds reveal they will be purchasing an asset is not illegal since the information is made public.

Understanding Front-Running

Understand front-running better with an example. A broker receives a request from a client to purchase 50,000 Company A shares. He keeps the order from the client until he executes an order for his personal account for the same stock. Then, when he places the customer's request, share price increases due to the scale of the customer's order.

The rise creates the broker an immediate benefit. Front-running, similar to insider trading, offers unfair profits to the broker who has confidential information that will affect the price of the asset.

  1. Companies and individuals are permitted to hold positions in assets that they recommend or discuss, but their position must be revealed at the time of recommendation or debate.
  2. Having a position is not illegal but trying to take advantage of non-public information is.
  3. A short-seller can pile up a short position and then reveal their research to the general public as to why they shorted the stock. This is not illegal because the short-seller tries to take advantage of the overall conditions, not just trying to profit from the release of their information. The latter would be a pump and dump version of short sell.