Forex trading can be a lucrative business, but it can also have its share of pitfalls. One of the risks that traders face is front running. Front running is a practice used by unscrupulous traders to gain an unfair advantage over others in the market. In this article, we will define front running in forex, how it works, and how traders can protect themselves from it.
What is Front Running?
Front running is the act of entering into a trade or taking a position in a financial instrument before a large order is executed, with the aim of profiting from the movement in price that the large order is likely to cause. Essentially, it is a form of insider trading, where the trader has access to information that others in the market do not.
For example, imagine a large hedge fund is planning to buy a significant amount of a currency pair. A trader who has access to this information may enter into a buy order for the same currency pair before the hedge fund executes its trade. The trader will profit from the increase in price that is likely to occur when the hedge fund buys the currency pair.
How Does Front Running Work?
Front running can occur in several ways. One common method is through the use of algorithms. Algorithmic trading is a computerized trading system that uses complex mathematical models to analyze and execute trades automatically. Traders can use algorithms to monitor the market and identify large orders that are likely to cause a significant movement in price. Once the algorithm detects a large order, the trader can enter into a position before the order is executed.
Another way front running can occur is through insider information. Traders who have access to confidential information about a large order or trade can use this information to their advantage. For example, an employee of a brokerage firm may have access to information about a large order from a client. The employee can use this information to enter into a position before the order is executed, thereby profiting from the movement in price that the order is likely to cause.
Why is Front Running Illegal?
Front running is illegal because it gives the trader an unfair advantage over others in the market. It violates the principle of fair competition and undermines the integrity of the financial markets. Front running can also harm investors who may be unaware that their orders are being front run. If the trader who is front running the order is successful, the investor may receive a worse price than they would have if the order had been executed without interference.
How to Protect Yourself from Front Running?
Traders can take several steps to protect themselves from front running. Firstly, they can use a broker who has strict policies and procedures in place to prevent front running. A reputable broker will have measures in place to detect and prevent insider trading and other forms of market manipulation.
Secondly, traders can use limit orders to execute trades. Limit orders specify a maximum or minimum price at which the trader is willing to buy or sell a currency pair. By using limit orders, traders can ensure that their orders are executed at a specific price, regardless of any movement in price caused by front running.
Finally, traders can use stop loss orders to limit their losses in the event of front running. A stop loss order is an order to sell a currency pair when it reaches a specific price. By using stop loss orders, traders can limit their losses in the event that the price of a currency pair moves against them due to front running.
Conclusion
Front running is a form of insider trading that gives traders an unfair advantage over others in the market. It is illegal and undermines the integrity of the financial markets. Traders can protect themselves from front running by using a reputable broker, using limit orders, and using stop loss orders. By taking these steps, traders can ensure that their trades are executed fairly and without interference.
