Have you ever wondered how and or why Wall Street Trading desks make so much money even when markets go down?
Especially on the fixed income side where I was employed. Its quite easy. Its called "Front Running" of customer proprietary orders.
Front Running is basically the illegal practice by traders who execute orders for its their own proprietary account before they execute that same order for clients. This type of trading is called trading ahead of your customer. The trader has advanced knowledge of a material pending order that would change current market pricing for that security, thus the trader has an unfair advantage, since he has this advanced information on customer orders.
As we all know, Wall Street has been printing money left and right so far this year. The main reason is the market maker/trader and prop trader is the same person. The person who sits on the desk who takes the order flow is also the same person trading the firms capital. With the advent of decimal pricing, front running on the equity side is business as usual. It was prevalent in the old days of fraction pricing, but this practice today is rampant. In the old days stocks traded in 1/8 - 1/16Th increments. That's is anywhere from 6.25 cents to 12.25 cents of easy spread arbitrage, market makers were killing em softly.
If a Market Maker got an order to sell 1000 shares of Cisco at 25, and the market is 24 15/16 - 25 1/16, most normally the MM would go in and show an offer of 1000 at 25 which would tighten that spread correct? Not in the old days. You would wait till someone lifts your offer for 1000 at 25 1/16, so someone just bought it from the MM at 1/16 higher then his customer. This is then easily crossed to the seller at 25. The MM just made .0625 for 1000 shares. All day long. This was common practice when NASDAQ Market Makers weren't by law mandated to show best bid/ask on the NMS. This was amended when the Manning Rule came into focus that outlawed hiding orders.
Now that all orders are shown in the best bid/ask, and we are pricing in decimals, profit margins have imploded, so the need to front run customer orders have increased.
If I am a NASDAQ Market Maker, I have advanced knowledge of proprietary material order flow. If I know that a "size" seller is coming into Google, I would just short the stock as I don't have to borrow the stock in advance as NMS MM's are exempt from stock loan rules. So the MM gets an order for 50,000 GOOG to sell at say 449.50 low. He sees ARCA in the book as a buyer for 10,000 at 450, instead of executing against ARCA for the client, the MM would execute vs ARCA for his own account first, then make it known he is a seller, pressuring the stock downward, all along making money on his short position. This is just a quick easy show of what happens, in actuality its a little more complex.
On the fixed income side, the desk flow traders (My Area), we had billions in balance sheet cash to play with, on top of that we had all of the information about who was buying and selling.
For a big buy side account (PIMCO/BLACKROCK/MFS) to get out of a position it usually takes up to a week and can move the price of as bond materially, so once a desk gets the first sell order from a BlackRock or the like, they immediately start reducing their own exposure or get short because they know that a huge amount of supply is coming. Also of note, the sheer size of supply on the bond side is staggering. It is not common to execute $100/200/300MM MBS orders.
So on top of the fact bond bid/ask spreads have moved from 10bp 2 years ago to 200bp now, these traders take huge prop positions and front run their clients orders.
Its unbelievably prevalent on the fixed income side of business today.
Its gotten to be out of control on the Equity Side. Just take a look at what I have posted about HFT.
tradersutra.blogspot.com/2009/07/whats-scary-about-hft-program-trading.html
tradersutra.blogspot.com/2009/07/real-hft-issue.html
tradersutra.blogspot.com/2009/07/volume-vs-liquidity.html
All of these big Wall Street firms have these HFT/Algo trading systems that basically front run customer trades.
How you may ask? Information inside these firms are all interconnected.
Also something called FLASH ORDERS.
These are customer orders that are flashed to the major market centers first then sent to the exchange. The Quant/Algo programs are so sophisticated and complex, that they process these flash orders so quickly via their program, that markets are manipulated.
dealbook.blogs.nytimes.com/2009/07/24/traders-profit-with-computers-set-at-high-speed/?scp=22&sq=flash%20orders&st=Search
The weird part is that every single person in the market knows what is going on and nobody does anything about it.
Why?
Two Reasons.
1-That is the price of doing business with GS, MS, CSFB, and others.
2-This is how Wall Street rolls!
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