Trading Ahead

Trading ahead occurs when a market maker trades securities from his firm's account instead of matching available bid and ask orders from market investors. This type of trading inhibits the standards and goals of orderly market trading which regulators seek to uphold through various rules and regulations.

Trading ahead is a violation of market trading practices. A market maker who uses securities from their own account ahead of the orders placed in the open market for execution is considered to be in violation of trading ahead. The act of trading ahead can occur through the development of standard market practices. Rules from the Financial Industry Regulatory Authority (FINRA) have been instituted to monitor and penalize market trading specialists who violate trading ahead rules.

Market makers also known as specialists are a key part of the infrastructure that facilitates secondary market trading. Market makers work to match buyers and sellers in the open market through a bid-ask trading system that allows them to profit from bid-ask spreads generated on each trade. The primary goal of market makers is to facilitate trading through the matching of buyers and sellers. However, if a trading scenario in which only one leg of the transaction is offered a specialist can trade from their own account to complete the trade.

Trading ahead is illegal when a market maker chooses to use securities from their own account to complete a transaction when unexecuted orders are available from investors. This act may provide an advantageous trading price to the market maker while inhibiting the fair market price for the open market. Trading ahead could also create an unsubstantiated profit for the market specialist. Overall, regardless of the motivation, trading ahead is considered a disruption to the orderly and efficient market trading standards which regulators seek to uphold for all investing participants.

Trading ahead was initially prohibited by NYSE Rule 92. Subsequently, in order to reduce regulatory duplication and streamline compliance, the NYSE and AMEX replaced Rule 92 with FINRA Rule 5320 which became effective from September 12, 2011.

FINRA Rule 5320 provides detailed direction on trading ahead and its prohibitions. The ruling also requires that market makers have documented policies and procedures regarding trading rules and that firms adhere to the documentation rules outlined in FINRA Rule 5310. Rule 5320 also provides for many exceptions to the prohibition of trading ahead. Exceptions include large orders and institutional orders, no-knowledge exceptions, riskless principal exceptions and ISO exceptions.