Front running: meaning and example

What is front running

Front running is when a broker, dealer or other insider trades for their own benefit ahead of a client's order they already know about, so they profit from the price move that order is likely to cause.

It is market abuse. It breaks the duty a firm owes its client, and securities regulators in most markets treat it as illegal.

Formal definition

In regulatory language, front running is trading in a security or derivative while holding material, non-public information about a pending client order or block trade. The trade is done in the person's own account, a related account or the firm's account, and it takes advantage of the expected price impact of that order.

It needs all three of these:

• Knowledge of a pending order that is not public.
• A trade placed before that order, in the same instrument or a closely linked one, such as an option or future on the same stock.
• An intent or effect of gaining from the price move the order creates, usually at the client's expense.

Worked example (hypothetical)

A fund tells its broker to buy a large block of shares in a listed company. The order is big enough to push the price up while it is being filled.

1. Before working the client order, a trader at the broker buys the same shares in a personal account.
2. The trader then fills the client order. Its size pushes the price higher, so the client pays more per share than before.
3. The trader sells the personal shares at the higher price.

The trader's gain comes from the client's order. The client gets a worse average price. This is front running in the stock market in its classic form.

Where the term appears

• Regulatory notices and court cases, when a supervisor fines or bans a trader or firm.
• Broker policies and order-handling disclosures, which explain how client orders are kept separate from the firm's own trading. See Compliance.
• News, often about fund managers, bank dealing desks or crypto exchanges.
• Crypto and DeFi, where bots watch pending transactions on a public blockchain and send their own ahead of them. See Decentralised finance (DeFi).

In Pakistan, the supervisor for securities and futures brokers is the Securities and Exchange Commission of Pakistan (SECP), with trading in listed securities and commodities only via SECP-licensed securities and futures brokers.

Edge cases for experienced readers

• Trading on public information is not front running. Buying ahead of a publicly announced index rebalance is sometimes called "index front running", but it uses public data and is generally legal.
• Tailgating is placing a personal trade right after a client order, copying it. It is also usually prohibited.
• Insider trading uses non-public information about the company itself. Front running uses non-public information about orders.
• Pre-hedging of block trades by dealers is a grey area. Rules on what a dealer may do before a client trade differ by market and are still being debated.
• Blockchain transaction ordering in DeFi often has no client relationship, so the legal status is unsettled.

Related terms

• Dealer
• Counterparty
• A-book and B-book
• Fill and partial fill
• Arbitrage
• Buy the rumour, sell the fact
• Trading glossary
• Regulation and Safety

Frequently asked questions

What is front running in simple words?

Someone who knows about a client's order trades first, so they gain from the price move that order causes.

Is front running illegal?

Yes, when it uses non-public knowledge of client orders. Securities regulators treat it as market abuse.

How is front running different from insider trading?

Insider trading uses secret information about a company. Front running uses secret information about pending orders.

Can a retail trader front run?

Only if they have non-public knowledge of someone else's orders. Reacting to public prices or news is not front running.

Does front running happen in crypto?

Bots in DeFi can place transactions ahead of others they see waiting on the blockchain. Whether this is illegal depends on the setting and is not settled.