What is 'front-running'?

This is a fun question with two different answers. There’s the textbook answer, where a broker executes a trade on their own account (or for a friend or VIP client) before filling a client’s order, and then there’s the colloquial use of the term, where traders try to buy and sell shares ahead of events (like rebalancing) or structural moves (tender offers).

> Textbook front-running:  The example I’d use here is where Sketchy Broker gets an order from DumbMoney Client to buy P50M worth of some mid-level stock. Sketchy Broker knows the size of the market, and so they also know that DumbMoney Client’s order is going to really move the price up. This is a newsworthy buy. Instead of entering the order right away, Sketchy Broker pulls out their phone and quietly buys up a bunch of that mid-level stock. Then, they enter DumbMoney Client’s order. They might sell some of their own shares into the DumbMoney Client’s buy order as the price of the stock climbs.

> Colloquial front-running:  This is just experienced traders using their knowledge to profit off the moves of the bigger players on the exchange. A good example is in the rebalancing of the PSEi’s composition. These rebalancing are done at specific points using well-known criteria, so it’s possible to make a very educated guess as to the potential inclusions and deletions, and to move in and out of those stocks before the general public gets the news and before the inclusion exposes the stock to the firehose of new buying demand. It’s not illegal or unethical, it’s just something that can be done with patience, knowledge, and skill.

MB bottom-line: The PSEi is a painfully difficult stock exchange for honest traders of any type. There aren’t enough companies on the exchange. Only a handful of stocks receive enough liquidity to maintain a robust trading market. Public floats are very low. Commissions are high. It’s a long-only exchange, so traders cannot transact for anything other than “I think this stock will go up.” There are no market orders, so people are stuck trying to snipe limit orders. There are no options. Enforcement of insider trading rules is largely non-existent. Insider information wins. Foreign flows dominate. 

None of us individually can “take a stand” to make any real change, and the vast majority of companies have floats so low that even if we did manage to collaborate and act collectively, we’d still be unable to overcome ownership’s supermajority voting power for all but a few existential corporate decisions. 

But that is our market. We make money on the margins of what the oligarchs, bankers, insiders, and foreigners do. Short-term and technical investors need to have whatever edge they can get to eke out gains, to maximize potential profit and minimize potential risk. Front-running is less applicable to long-term or value investors, but even for traders like us, it makes sense to consider the impact of PSEi inclusion or exclusion on our investments, and in that respect, we are starting to think and act like front-runners. It never hurts to learn more about something, and in this market, if you follow the money, the best place to start learning more is in the arena of PSEi rebalancing.

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