Front Running: Definition, Examples, and Impact

Front running is an unethical or illegal trading practice where a trader uses advance knowledge of pending orders to gain a market advantage. It occurs in various markets, including stocks, cryptocurrencies, and commodities.

How Front Running Works

Front running typically happens when an insider, such as a broker, miner (in crypto), or market maker, places a trade before executing a large client order, profiting from the price movement caused by that order.

Examples of Front Running

1. Stock Market Front Running

Suppose a stockbroker receives a large buy order from a mutual fund to purchase 1 million shares of Company XYZ. Knowing that this order will likely push the stock price up, the broker secretly buys shares for themselves before executing the client’s order. When the price rises, they sell at a profit.

2. Cryptocurrency Front Running

In decentralized finance (DeFi), front running occurs when blockchain miners or bots detect large pending transactions and insert their own trades ahead of them. For example, a trader places a large order to buy ETH on a decentralized exchange. A bot detects this, places a buy order with higher gas fees to execute first, and then sells the ETH at a higher price once the original trade is processed.

3. Commodities Market Front Running

In the commodities market, a broker working for a hedge fund might learn that the fund is planning to buy a large quantity of crude oil futures. The broker buys futures beforehand and profits when the hedge fund's order increases the price.

Impact of Front Running

• It undermines market fairness and transparency.
• Retail and institutional investors suffer losses due to price manipulation.
• It is illegal in regulated markets and can lead to severe penalties.

Regulatory Actions

Regulatory bodies like the SEC (U.S.), FCA (U.K.), and CFTC (commodities) impose strict rules against front running. In the crypto space, decentralized exchanges are implementing solutions like transaction ordering protection to prevent front running.

Conclusion

Front running is a serious issue in trading markets, harming investors and distorting prices. While legal enforcement exists in traditional finance, the crypto sector is still working on effective countermeasures.