======Front-running======
Front-running is the illegal and unethical practice of a broker or other market intermediary using advance, non-public knowledge of a large client order to execute a trade for their own personal benefit. By "running in front" of the client's trade, the intermediary profits from the price movement that the large order is expected to cause. Think of it like this: you tell your real estate agent you're about to make a huge offer on a house, an offer so big it will surely raise the property's perceived value. Before submitting your offer, your agent quickly buys the house for themselves, only to sell it to you or another buyer at the higher price they knew was coming. This is a classic bait-and-switch that abuses the trust placed in the agent. In the financial world, it's a direct breach of a [[fiduciary duty]] and fundamentally undermines market fairness, as the intermediary is effectively stealing a profit opportunity that belongs to their client.
===== How Does It Work in the Wild? =====
The mechanics of front-running are deceptively simple and prey on the basic laws of [[supply and demand]]. The process typically unfolds in a few steps:
  - 1. **The Big Order:** A large institutional investor, like a [[pension fund]] or a [[mutual fund]], decides to buy a massive block of shares in a company—say, 200,000 shares of Acme Corp.
  - 2. **The Tip-Off:** The institution places this huge [[buy order]] with their [[broker]]. The broker now possesses valuable, non-public information: a massive purchase is imminent, which will very likely push the stock price of Acme Corp. higher, at least for a short time.
  - 3. **The Front-run:** Before executing the client's order, the broker (or an associate with this information) quickly buys a smaller number of Acme shares for their own personal account at the current, lower price.
  - 4. **Execution and Profit:** The broker then executes the client's huge 200,000-share order. As predicted, this surge in demand drives up the stock price. The broker then sells their personal shares at the new, inflated price, pocketing a quick, low-risk profit.
The ultimate victim is the client. The pension fund, in this case, ends up paying a slightly higher average price for its shares than it would have otherwise. While it might only be a few cents per share, multiplied by 200,000 shares, it adds up to a significant loss that is passed on to the fund's beneficiaries—everyday people with retirement accounts.
===== Types of Front-running =====
While the principle remains the same, front-running has evolved with technology.
==== Traditional Front-running ====
This is the classic scenario described above, involving a human broker consciously deciding to cheat a client. While regulators have cracked down on this, it still poses a risk in less-transparent markets or with unscrupulous individuals.
==== Algorithmic Front-running ====
Welcome to the 21st century, where the crime is the same, but the culprit is a computer algorithm. This modern form is often associated with [[High-Frequency Trading]] (HFT).
  * **Speed is Key:** HFT firms engage in [[co-location]], placing their computer servers in the same physical data centers as a stock exchange's servers. This proximity gives them a speed advantage measured in microseconds.
  * **Digital Eavesdropping:** Their lightning-fast algorithms can detect the initial parts of a large order hitting an [[electronic communication network]] (ECN).
  * **Automated Execution:** The algorithm instantly fires off its own buy order, getting it filled fractions of a second before the large institutional order is fully processed. It then sells moments later for a tiny profit. Repeated thousands of times a day, these tiny profits become enormous.
==== Index Front-running ====
This is a more specialized variant. When a company is publicly announced to be joining a major stock index like the [[S&P 500]], its price often jumps. This is because all the [[index funds]] and [[ETFs]] that track that index are now //forced// to buy the stock to rebalance their portfolios. Traders who learn of an index addition //before// it's officially announced can buy shares in advance and ride the wave of forced buying. Using this non-public information is illegal, though profiting from the public announcement itself is a legitimate trading strategy.
===== Is It Legal? And Why Should a Value Investor Care? =====
==== The Legality ====
Let's be crystal clear: **front-running is illegal.** In the United States, regulators like the [[Securities and Exchange Commission]] (SEC) and self-regulatory bodies like [[FINRA]] have strict rules against it. In Europe, directives such as [[MiFID II]] aim to stamp out such manipulative practices. It violates the core duty of "best execution," which requires brokers to secure the most favorable terms possible for their clients.
==== The Impact on You ====
As a retail [[value investor]], you're unlikely to be placing orders large enough to be a direct target yourself. Your purchase of 50 shares won't move the market. However, front-running is a hidden tax on the entire system that affects you indirectly:
  * **Erodes Your Returns:** It raises transaction costs for the large mutual funds and pension funds in which you are likely invested. This systematic "skimming" eats away at their performance, which in turn reduces your long-term returns.
  * **Damages Market Integrity:** Value investing thrives on the belief that, over time, a company's stock price will reflect its true [[intrinsic value]]. Front-running distorts this process of [[price discovery]], creating artificial price movements based on order flow rather than business fundamentals. It fosters the belief that the market is a "rigged game," which can damage investor confidence for everyone.
Ultimately, knowing about front-running is part of being a sophisticated investor. It's a powerful reminder that while you're focused on balance sheets and business moats, others are playing a different, faster game. Understanding these market dynamics helps you maintain a realistic and informed perspective on your investment journey.