Front Running Forex Orders
Updated: May 20, 2013 at 9:56 AM
Another common form of currency market manipulation, and perhaps the closest activity to insider trading in the forex market, would be front running large currency orders.
Front running is a rather questionable market manipulation strategy often used by brokerage companies or banks with large individual and corporate customers.
These clients sometimes leave substantial orders in the market at target rates, rather than taking the time to watch the market and then ask for a price when it approaches their desired action level.
As an example of front running, the party holding an order for an especially large commercial transaction might trade ahead of or "front run" the order in the way described in the following sections.
Receiving the Order
First, a bank's customer desk might receive a request to work an order on a large transaction. For example, consider the situation if this involved selling 500,000,000 U.S. Dollars versus the Japanese Yen at a USD/JPY exchange rate of 100.00 when the market in USD/JPY is currently trading at 99.95.
Such a large commercial order might come from a Japanese automobile exporter when the market is approaching their target price for converting profits from U.S. car sales, for instance.
Communicating it to the Bank's Market Maker
The person on the dealing desk that takes the order immediately communicates the currency pair, size and direction of the huge commercial transaction to the USD/JPY market maker on the bank's currency trading desk.
Since the market is close to the order level, the market maker immediately begins selling USD/JPY for the bank's trading account. They effectively front run or trade ahead of the huge order that is waiting to be executed at slightly higher rates.
Outcomes of Front Running
If the market then trades lower as a result of their front running activities, then the market maker can close their accumulated short position at a profit. They can then just start selling again if the market rises toward the order level.
Nevertheless, if the market does manage to trade higher to the order level at 100.00, then they can use the order to stop themselves out for just a 5 pip loss. Also, the execution of the large order at that level will eventually tend to drive the market down as players realize that a large amount is waiting to be sold.
Also, if the market lacks sufficient upward momentum for the entire order to be filled, then the bank trader might just close out any executed amount for yet another profit. If asked, they would then simply inform the customer that market buying interest was insufficient to execute their entire huge amount at that level.
The rather obvious conflict of interest here and why this qualifies as forex market manipulation is that the customer wants their order filled, but the front running activities of the market maker working the order will tend to prevent the market from filling the order.
Risk Statement: Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you.