The act of entering a trade
, either with a long
or short position
, knowing that other investors
are about to take a position that will positively influence one's own. For example, one may buy
Security A knowing full well that other investors are also about to buy Security A in large blocks, causing its price to increase. This will allow the investor to sell
Security A at a much higher price. Front running is forbidden by the SEC
as a form of insider trading
. It is also known as stepping in front or pennying.
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.
If you trade stock or other investments because you know that an upcoming transaction by a third party is likely to affect the market price of the investment, you're front running.
Because front running, sometimes known as forward trading, relies on information that isn't available to the general public, it's considered unethical in certain circumstances.
One example is a broker-dealer who trades at a better price for a personal account than for a client's account.