GO
Loading...

Front running: CNBC Explains

Simon Smith | Vetta | Getty Images

In a foot race, a front-runner takes off ahead of the pack and hopes to build an insurmountable lead. In the stock market, it's someone who takes off ahead the same way but then tries to convince the rest of the pack that he or she is not really a front-runner.

Such is the convoluted world of Wall Street trading, where competitors will go to extreme lengths to try to outwit the competition.

In conventional terms, front running is something that happens within a firm: A trader gets word that a customer is interested in purchasing a big block of a company's shares, and that trader will purchase shares for his individual account before executing the customer's order. When the customer's purchase gets executed, the price rises and the trader pockets the difference between the new price and what he paid.

However, that definition, or at least the term's connotation, has changed some recently.

In the Michael Lewis book "Flash Boys," he applies the term to traders who use lightning-quick computer programs—high-frequency trading—to detect orders from rival traders, then jump in front of that trade. The effect is that the rival has to buy at a higher cost and the value of the front-runner's purchase goes higher.

Front running is not on its face illegal. It only rises to that level if the trader is using information not available to the public.

"Is it the downside of a very electronic world in which we live, or is it something that much more clever?" said Diane de Vries Ashley, a professor of corporate finance at Florida International University. "My deepest suspicion would be a little bit of both."

Contact CNBC Explains

  • CNBC NEWSLETTERS

    Get the best of CNBC in your inbox

    › Learn More

Latest Special Reports

  • With the world becoming more interconnected, it’s getting harder to anticipate and manage global risks. We take a look at some of the biggest risks and ways to mitigate them.

  • From family-run companies to public companies with family ownership, we tackle challenges and rewards facing family businesses.

  • Inside the market's biggest sectors with a look at the trends, companies and trades netting profits for investors.

Central Banking Explained

Corporate Accounting Explained