High-frequency traders–on the whole–don’t front run institutional orders.
That’s the conclusion of Jonathan Brogaard, a JD-PhD candidate at the Kellogg School of Management at Northwestern University, in a paper released in September.
While Brogaard says he can’t be sure that high-speed traders don’t front run at all, in the main, his research proves front running is not a predominant trading strategy.
Brogaard defines front running as the ability of an HFT to discern a large order in process and then take the same position ahead of the institution.
The academic looked at trading patterns, comparing the activities of HFTs with those of non-HFTs. "The probability of patterns consistent with front running do not appear more often than if trading was random," Brogaard states.
Brogaard looked at trading in 120 different stocks using data from Nasdaq OMX and the Center for Research in Security Prices, covering 2008, 2009 and five days in February 2010.
Data from Nasdaq includes 26 firms identified by Nasdaq as engaging primarily in high-frequency trading. These firms engage in proprietary trading; they do not have customers and use their own capital.
To determine whether HFTs front run the orders of non-HFTs, Brogaard postulated that he would frequently find one or more trades by HFTs before those of non-HFTs. In fact, he found the opposite. Less than 20 percent of the 120 stocks showed trades that would indicate front running.
"HFTs do not seem to systematically front run non-HFTs," Brogaard concludes.
Some executives are skeptical. Ian Domowitz a managing director at agency brokerage Investment Technology Group, which has written its own report critical of high-frequency trading, finds Brogaard’s report "subjective" but "still interesting and based on the data," he reported in his blog.
