What's the limit with front-running?

saveonarola

A stupid question, maybe, but bear with me.

The phenomenon of 'front-running' is well-known. Index funds are forced to add or divest certain securities at certain times, which creates more-or-less predictable rises and falls in demand, which are then exploited by other market participants, to the detriment of investors in the index fund. Similarly, traders buy up futures contracts knowing that index-tracking ETFs have no choice but to roll them over as they approach maturity, meaning that ETFs effectively pay a higher price than they would otherwise.

Could the same thing be possible more generally? For example, do large institutional investors make any attempt to spread out their purchases, in order not to create predictable demand for certain securities - I'm thinking of those in index funds in particular - that could then be exploited by more fleet-footed investors. Don't a lot of company pension contributions get invested at the end/beginning of the month and couldn't this cause a spike in demand, if lots of large institutions were investing new money at the same time? I've done a bit of searching and I can't find anything on this, probably because it's uninformed, paranoid nonsense, but I would be interested to hear why.

Linton

Surely the market would smooth things out. If everyone knew there would be a big demand on day 10, many people would buy on day 9 bringing the demand forward, but then everyone would know that was going to happen so would buy on day 8 etc etc.

sabretoothtigger

You need to know about a really large buyer to front run in an open market. Many people spend their lives trying to do this, its a normal part of an efficent market not a secret

Someone like Buffet will spread their purchase to stop a spike in the price as he can swamp available sellers and cause them to demand more.
He said he bought Coke every day for months in large amounts, that activity will appear in price and volume and some will buy knowing its a price likely to keep rising

You can front run money outflow from bonds. People front run QE purchases, you need millions to do that.
There is merger arbitrage, this is a subject big enough to do a degree or Phd on
Qatar just front run the XTA GLEN merger successfully it appears, I bought some myself They took 10% and demanded a higher price to sell.
Could try to front run RBS direct line shares, its a new part of the index ?

gadgetmind

Please have tried to model what impact this effect would have on trackers and the numbers always come out as teeny fractions of a percent.

Jegersmart

What is the limit? What do you mean?

saveonarola

Jegersmart wrote: »

What is the limit? What do you mean?

I just meant what I said in the post - whether some demand was predictable and therefore likely to be front-run. Maybe I've got this wrong, but don't most salaried people get paid towards the end of the month, so all their pension contributions would be invested around that time? But as others have said, this is presumably a) not significant relative to overall market flows, or b) mitigated by spreading out purchases or something like that.

Thanks for the answers.

grey_gym_sock

i doubt if monthly pension contributions have any noticeable effect. i imagine not much of the money is automatically/immediately used to buy securities, and more of it initially stays in cash until somebody makes a decision. for company pension schemes, contributions can partly be matched against outgoing funds for ppl retiring, so not all of it will require any new investment. and employers and schemes will do things on slightly different dates.

sabretoothtigger

The largest part of the market sloshing around is borrowed money, they call it hot money

A large part of that relates to Forex markets or interest rates. If they put up interest rates it sends that money back to pay off the debts instead of being invested.

The answer to your question is its not simple. If you understand why Japanese money is flowing to the dollar you can become a billionaire, you will have very valuable information but nobody reallys knows this answer why. Are you the next George Soros.

FOREX > Bonds > Commodities > Shares

If you want to front run you have to know where the money will come from, shares are on the end of a bull whip

When we try to discuss why money is dangerous to invest in due to forex instability, lack of asset or trade backing to currency value the mods say avoiding this money value loss is not relevant to saving money and remove the thread.
So if it is possible to learn this stuff you probably need to try another forum or more likely find a good book