Order Anticipators: Front-Running, Sentiment Trading, and Parasitic Strategies (Chapter 11)

Chapter 11 is about the market’s parasites. Not informed traders who make prices more accurate. Not dealers who provide liquidity. These are the order anticipators: traders who profit by getting in front of other people’s trades. They do not improve anything. They just take.

Harris is pretty direct about this. Order anticipators are parasitic traders. They profit only when they can prey on other traders. They do not make prices more informative, and they do not make markets more liquid. But understanding how they operate is essential because if you trade, you are their potential target.

Three Types of Parasites

Order anticipators come in three flavors.

Front runners collect information about trades that other traders have already decided to make. They race to trade before those orders hit the market.

Sentiment-oriented technical traders try to predict trades that uninformed traders will decide to make in the future. They are forecasting sentiment rather than reacting to known orders.

Squeezers corner one side of a market so that anyone who needs to close a position on the other side has to negotiate with them at whatever price they set.

All three are essentially the same play: trade before someone else, profit from the price impact of their trading.

Front Running: The Classic Parasitic Play

Front running is the most straightforward of the three. Someone has a large order to fill. You find out about it. You trade first. You profit from the price movement that their order creates.

Harris gives a vivid example. Rob is a runner on a futures exchange floor. He carries orders from the phone booth to brokers in the trading pits. His buddy Nate trades for his own account. They have arranged signals: a glance at a clock, which hand carries the order, the placement of a pen. When Nate sees the signal for a large buy order, he immediately buys contracts for himself. After the broker fills the customer’s order and pushes the price up, Nate sells at a profit. They split the money.

The customers pay for this. They get worse prices because Nate took the liquidity they would have received.

Not all front running is illegal, though. Observant floor traders can sometimes infer orders from how a broker behaves. Harris describes Rifka, who has traded near Jon for years and can tell from subtle behavioral cues when he has a large order. She cannot even articulate what she sees. She just knows. Her trading is legal because she earned her insight through observation, not through a breach of confidentiality.

Front Running Passive Traders: Quote Matching

Front runners do not just target aggressive traders with market orders. They also prey on passive traders who post limit orders. This is called quote matching, and since decimalization of U.S. stock markets, it is also known as penny jumping.

Here is how it works. Jose places a large limit buy order at 20 pesos. Maria sees it and immediately posts her own buy order at 20.01. An incoming sell order fills Maria’s order instead of Jose’s. If the price goes up, Maria profits fully. If the price goes down, she sells to Jose at 20, losing only one centavo. Her return distribution is wildly asymmetric: unlimited upside, tiny downside. As long as Jose does not cancel his order, Maria is essentially getting a free option.

Harris notes that Jose can fight back. He can cancel his order when he suspects someone is front-running him. Or he can set a trap: post a fake buy order, wait for a quote matcher to jump in front, then immediately sell to the quote matcher and cancel his own buy order. Now the quote matcher is stuck with Jose’s problem.

The Impact on Markets

Front running makes markets worse in nearly every way.

It does not provide liquidity. Front runners do not show up to trade when there is nobody to front-run. They bring nothing new to the table. They just extract value from trades that would have happened anyway.

It hurts informed traders. When front runners front-run informed traders, they speed up the price adjustment, which sounds good. But in the long run, front running reduces informed traders’ profits, which means fewer informed traders enter the market, which means prices become less informative.

It increases transaction costs. Since trading is zero-sum, front runner profits are directly someone else’s transaction costs.

The only theoretical scenario where front running helps is when front runners are genuinely better traders than the people they are front-running. If they can consolidate the other side more cheaply than the large trader can, they might actually lower costs. But this requires front runners who do not compete with each other and do not squeeze their targets. That almost never happens.

Sentiment-Oriented Technical Traders

These traders are a step removed from front runners. Instead of trading on orders that already exist, they try to predict what uninformed traders will decide to do.

They study the patterns that drive uninformed trading. Investment cash flows from year-end bonuses and pension contributions. Hedging demand from option dealers who need to dynamically replicate their positions. Foreign exchange flows from IPO subscriptions in Asian markets. Even the mistakes that bad speculators repeatedly make.

Harris gives the January Effect as an example. Historically, U.S. stock prices have risen more in January than in any other month. One explanation: year-end bonuses and pension contributions get invested in January, pushing prices up. Sentiment traders who can predict these cash flows buy in December to get ahead of the flow.

The risk with sentiment trading is that you are front-running uninformed traders whose price impact moves prices away from fundamental value. When value traders show up and push prices back, sentiment traders lose. So this strategy works best in instruments that are hard to value, where value traders are less aggressive. Stocks in developing industries, emerging market securities, or instruments whose values depend on hard-to-measure factors like expected inflation or political uncertainty.

Harris also discusses asset bubbles in this context. When traders buy an asset because they expect it to keep appreciating (regardless of fundamental value), sentiment traders may jump in to ride the momentum. But they must be extremely careful. When sentiment shifts, bubbles burst instantly.

Squeezers: Cornering the Market

Squeezers are the most aggressive type of order anticipator. They deliberately monopolize one side of a market so that anyone who needs to close a position on the other side is at their mercy.

The classic example is Benjamin Hutchinson’s Great Wheat Corner of 1888. He bought thousands of September wheat futures contracts while simultaneously buying up the physical wheat supply in Chicago’s grain elevators. As the delivery date approached, traders who had sold short needed to either buy back contracts or deliver wheat. Hutchinson refused to sell either. Wheat prices doubled in eight days. He made millions.

Harris compares squeezing to “shooting the moon” in Hearts. If you collect every penalty card, everyone else loses big. But if you get close and miss, you lose badly. Similarly, a failed squeeze is catastrophic because the squeezer pushed prices up to build the position and now has to sell into a falling market.

There is also the short squeeze variant. A value trader shorts an overpriced penny stock. The stock’s promoters, who want to keep the fraud going, demand the borrowed shares back while buying on the open market to push the price up. The short seller cannot find shares to borrow elsewhere and is forced to buy at inflated prices. Even though he was right about the stock being worthless, he loses money.

Squeezes are now illegal in the U.S. The CFTC monitors futures positions as contracts expire. The SEC watches stock trading. But proving a squeeze versus legitimate speculation is difficult, so short sellers must always beware.

Gunning the Market

One more parasitic strategy worth mentioning: manipulating stop orders. If shrewd traders know where stop loss orders are clustered, they can push prices to trigger those stops. The stop orders then accelerate the price movement, and the manipulators sell into the resulting flow.

Harris gives the silver example. The price is 4.96. The manipulator knows many stop loss buy orders sit at 5.00. She aggressively buys to push the price from 4.96 to 5.00, triggering the stops. She then sells her position to the stop order traders at 5.00. Average cost: 4.98. Free money. And since futures require only a small margin deposit, the return on capital is enormous.

This is technically illegal, but nearly impossible to prosecute. The manipulator just says she thought the price was too low and sold when her expectations were met.

The Takeaway

Order anticipators are the reason traders need to guard their information so carefully. If you are a large trader, splitting your orders, hiding your intentions, and being strategic about when and how you show your hand is not paranoia. It is survival. Every piece of information about your trading intentions has value, and there are people whose entire strategy is extracting that value before you can act on it.

This post is part of a series on Trading and Exchanges: Market Microstructure for Practitioners by Larry Harris (Oxford University Press, 2003). Chapter 11 covers order anticipation strategies.

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