What Causes a Stock Market Bubble?

What Causes a Stock Market Bubble?

What Is a Stock Market Bubble?

Market bubbles–when prices become extremely detached from an asset’s fundamental value–tend to be a fixation for stock investors.

Stock market bubbles are notoriously difficult to spot but are famous for potentially causing large-scale consequences, such as market crashes and recessions.

For investors on an individual level, entering the market in the later stages of a bubble could mean painful losses. But misdiagnosing a stock market bubble or exiting from positions too early can result in an investor missing out on potential gains.

Here’s a deeper dive into what causes stock market bubbles and how they develop.

Five Stages of a Market Bubble

Modern-day investors and market observers typically categorize market bubbles based on the principles of Hyman P. Minsky, a 20th century economist whose financial-instability hypothesis became widely cited after the 2008 financial crisis.

Minsky debunked the notion that markets are always efficient. Instead, he posited that underlying forces in the financial system can push actors–such as bankers, investors and traders–toward making bad decisions.

Minsky’s work discussed how bubbles tend to follow a pattern of human behavior. Below is a closer look at the five stages of a bubble cycle:

1. Displacement

Displacement is the phase during which investors get excited about something — typically a new paradigm such as an invention like the Internet, or a change in economic policy, like the cuts to short-term interest rates during the early 2000s by Federal Reserve Chair Alan Greenspan.

For instance, one example of displacement can be the enthusiasm for cryptocurrencies that picked up in 2017. While the cryptocurrency market technically began back in 2009, mainstream institutional and retail investors started gravitating toward crypto coins and tokens like Bitcoin in a bigger way in 2017.

Recommended: A Beginner’s Guide to Cryptocurrency

2. Boom

That excitement for a new paradigm next leads to a boom. Prices for the new paradigm rise, gradually gathering more momentum and speed as more and more participants enter the market. Media attention also rapidly expands about the new investing trend.

This phase captures the initial price increases of any potential bubble. For instance, after Greenspan cut interest rates in the early 2000s, real-estate prices and new construction of homes boomed. Separately, after the advent of the Internet in the 1990s, shares of technology and dot-com companies began to climb.

3. Euphoria

The boom stage leads to euphoria, which in Minsky’s credit cycle has banks and other commercial lenders extending credit to more dubious borrowers, often creating new financial instruments. In other words, more speculative actions take place as people who are fearful of missing out jump in and fuel the latest craze. This stage is often dubbed as “froth” or as Greenspan called it “irrational exuberance.”

For instance, during the dot com bubble of the late 1990s, companies went public in IPOs even before generating earnings or sales. In 2008, it was the securitization of mortgages that led to bigger systemic risks in the housing market.

4. Profit-Taking

This is the stage in which smart investors or those that are insiders sell stocks. This is the “Minsky Moment,” the point before prices in a bubble collapse even as irrational buying continues.

History books say this took place in 1929, just before the stock market crash that led to the Great Depression. In the decade prior known as the “Roaring 20s,” speculators had made outsized risky bets on the stock market. By 1929, some insiders were said to be selling stocks after shoeshine workers started giving stock tips–which they took to be a sign of overextended exuberance.

Recommended: A Brief History of the Stock Market

5. Panic

Panic is the last stage and has historically occurred when monetary tightening or an external shock cause asset values to start to fall. Some firms or companies that borrowed heavily begin to sell their positions, causing greater price dips in markets.

After the Roaring 20s, tech bubble, and housing bubble of the mid-2000s, the stock market experienced steep downturns in each instance–a period in which panic selling among investors ensued.

Recommended: Should I Take My Money Out of the Stock Market?

The Takeaway

One of the prevailing beliefs in the financial world is that markets are efficient. This means that asset prices have already accounted for all the information available. But market bubbles show that sometimes actors can discount or misread signs that asset values have become inflated. This typically happens after long stretches of time during which prices have marched higher.

Stock market bubbles are said to occur when there’s the illusion that share prices can only go higher. While bubbles and boom-and-bust cycles are part of markets, investors should understand that stock volatility is usually inevitable in stock investing.

Investing has historically been an important part of wealth-building for individuals, and the benchmark S&P 500 Index has an average market return of 7% annually after adjusting for inflation.

With the SoFi Invest online trading platform, members can use the Active Investing feature to pick and choose company stocks, exchange-traded funds (ETFs) and fractional shares. For those who want a more hands-off approach, the Automated Investing service builds, manages and rebalances portfolios for individuals based on their risk tolerance and investment time horizon.

Get started on SoFi Invest today.

Photo credit: iStock/fizkes


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
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What are Smart Contracts: 2021 Guide

2021 Guide to Smart Contracts

While the best known use of the blockchain is to store and transmit digital currencies, the blockchain also has many other uses. Among those uses are smart contracts, which makes use of the blockchain technology to automatically execute all or part of the agreements between two parties.

Some users are already using them to do business in the real estate and insurance industries, and they’re a big part of the decentralized finance industry.

Recommended: 9 Blockchain Uses and Applications in 2021

What Is a Smart Contract?

A smart contract is a digitally facilitated agreement between two parties that’s written in code into the blockchain technology. The code automatically executes the terms of the contract when agreed upon conditions occur. There is no third-party required to enforce the terms of the agreement.

How Do Smart Contracts Work?

Rather than having people and institutions back up a contract’s provisions, the blockchain automatically enforces it — “every node in the network holds a copy of the transaction and smart-contract history of the network. Every time a user performs some action, all of the nodes on the network need to come to agreement that this change took place,” according to Coindesk. This feature of smart contracts leverages the security of blockchain technology.

A Short History of Smart Contracts

The idea behind smart contracts predates the blockchain technology that made them possible. Cryptography and digital currency pioneer Nick Szabo, first used the term in the 1990s to describe “a set of promises, specified in digital form, including protocols within which the parties perform on these promises.”

What makes smart contracts “smart,” according to Szabo is that the contract is specified in a computer program or in code, that the contract is executed digitally, and that the exchange of goods that happens due to fulfillment or non-fulfillment happens in the same code or program in which the contract itself was written.

What helped make self-executing, smart contracts a reality was the development of the cryptocurrency Ethereum blockchain, which enables Ethereum.

Smart Contract Examples

While smart contracts are still a relatively new technology, several use cases for them have already emerged.

Decentralized Finance

Perhaps the most obvious arena for smart contracts is, well, money. After all, cryptocurrency is used as just that, a currency, and finance often consists of contracts between two parties surrounding the exchange of money over time.

Think of a typical loan payment, it’s a contract under which one party provides another with a certain amount of money and the other party agrees to transfer money back to the first party at certain dates and in certain amounts, if the borrower does not pay the lender, the lending party can commence legal action against the borrower.

Decentralized finance” seeks to use smart contracts to create financial products like loans that do not rely on third parties. Decentralized finance or “DeFi,” is one of the hottest areas of blockchain technology.

There are several examples of smart contracts in decentralized finance. One of the most prominent are “stablecoins” — cryptocurrency tokens with a fixed value. One stablecoins, Dai, is pegged at a one-to-one value with the dollar. Dai uses smart contracts for the creation of new tokens and governance of the entire token ecosystem.

Recommended: What Is a Stablecoin? A Closer Look

In practice, that means that if a user wants to issue new Dai tokens, they need to stake ethereum as a collateral. If the value of that underlying collateral falls below a certain threshold, the smart contract automatically sells the collateral in order to make up the difference.

Real Estate

One of the most enticing areas to use blockchain is in real estate. When purchasing a home, for example, you set up a contract with a bank and money transfers with the previous owners in exchange for what are essentially a set of legal rights to a property. This process is time-intensive, requires various agents and lawyers on both sides, as well as several complex transfers of money both at one time and over years. This is an area where smart contract developers have been hungry to get into.

While it’s unlikely that you’ll move into the house of your dreams by executing a smart contract, blockchain developers are looking into real estate by “tokenizing” properties, divvying up real estate into slices that investors can own or trade (including through smart contracts).

Here are a few companies already using smart contracts in real estate:

•  Harbor is using smart contract to tokenize a $100 million real estate fund.

•  DigiShares allows real estate developers to tokenize their projects using smart contracts.

•  Ubiquity uses black-chain based smart contracts to tokenize real estate and help reduce costs during escrow.

•  SmartZip, a real estate software company, has partnered with blockchain firm Chainlink to provide real estate pricing data to smart contracts.

•  Propy is a blockchain startup that facilitates real estate escrow through smart contracts.

Insurance

Insurance is another example of a complicated financial contract that many entrepreneurs and developers are looking to deploy blockchain technology in. Blockchain in insurance can mean a lot of things.

One possible model for it is “parametric insurance,” which pays out automatically under certain conditions that are definable in code in a smart contract. This is still an emerging area, but since the insurance industry relies on millions of contracts, it’s a natural area for blockchain smart contract developers to look into.

Here are a few ways smart contracts are actually being used in the insurance industry:

•  The Institutes RiskStream Collaborative is a consortium of 40 insurance industry members working together to build blockchain applications for industry use

•  IBM uses its blockchain technology to automate insurance underwriting using smart contracts.

•  Etherisc is a decentralized insurance protocol insurers are using for smart contracts and other services.

•  Sprout is an insurer that uses smart contracts to provide crop insurance to farmers.

•  Nexus Mutual serves as a decentralized insurance platform that aims to eliminate the need for third-party insurers.

The Takeaway

Smart contracts are one use for the blockchain, made possible in many cases through the adoption of cryptocurrency. Many investors view cryptocurrency, and the blockchain that makes it possible, as an important part of their investment portfolio.

An easy way to get started investing in crypto is by opening an account on the SoFi Invest® brokerage platform. SoFi Invest offers access to a range of cryptocurrencies including Bitcoin, Litecoin, and Ethereum, with up to a $10 bonus for your first trade.

Photo credit: iStock/fizkes


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.
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SegWit: Definition & How it Works

SegWit: Definition & How it Works

SegWit is an update to Bitcoin’s protocol that changed the way that the blockchain transfers information. Protocols are the rules that govern the way that Bitcoin and other cryptocurrencies work.

What Is SegWit?

SegWit is an example of the Bitcoin development community being able to solve a problem while still maintaining the integrity of the Bitcoin protocol and blockchain.

SegWit stands for “segregated witness,” and it’s a key turning point in the history of Bitcoin and cryptocurrency, and represents a fork in the road, or at least a fork in Bitcoin. The SegWit fork changed the rules, allowing for larger blocks and removing signature data from Bitcoin transactions.

How Does SegWit Work?

SegWit removes (or segregates) the signature (or witness) from the block, moving it instead to the back of the transaction. This frees up more space for the transaction itself.

What Problems Does SegWit Solve?

SegWit solves several issues with earlier versions of the Bitcoin protocol.

The Transactions Problem

The original Bitcoin protocol limits the size of “blocks” to a single megabyte. The whole Bitcoin network “confirms” a new block every ten minutes, with a few transactions taking place every second. These blocks and the confirmation process comprise the foundation of Bitcoin.

As Bitcoin scaled and got bigger and more miners, developers, and users became part of the Bitcoin community, a debate arose around the size of blocks. Should it increase beyond founder Satoshi Nakamoto’s original vision or stay the same?

If the community decided to make an increase, it would have to receive approval by consensus, or perhaps risk splitting Bitcoin apart into separate protocols.

The Malleability Problem

The Blockchain also had some security and efficiency issues, known as “malleability.” Prior to Segwit, every Bitcoin transaction included a “signature” that became part of the transaction confirmation. The signature, with the use of a private key, would become part of the block transfer, taking up space that could have been more Bitcoin transactions. Another word for these signatures is “witness,” and so was born the idea of Segregated Witness, or SegWit.

The theory behind SegWit held that Bitcoin transactions could be more efficient, more secure, and better recorded on the Blockchain itself. This would also allow for developers to build transfer improvements on top of the original Bitcoin protocol, leading to the development of the Lightning Network.

The Scalability Problem

One of the major issues addressed by SegWit was the so-called “scalability problem,” which refers to the issue with block sizes that can limit the speed and scale of transactions on a Blockchain network.

When Was SegWit Created?

The Bitcoin Segwit update took place on August 23, 2017 and changed the way information was transferred on the blockchain.

Prominent Bitcoin developer Pieter Wuille originally proposed the update in 2015 as a way to address a problem in the less-than-a-decade-old protocol that governed the cryptocurrency. He and others believed that transactions took too long to process and that they had some security issues.

There were two ways, known as forks, to address the problem.

A hard fork

A hard fork creates a new system all together. Bitcoin Cash is an example of a hard fork, which enabled large block sizes, but ultimately created a new network.

A soft fork

With a soft fork, the new system works with the old one. This is the option that developers used for SegWit, which became one of the most prominent and important Bitcoin forks. In the dispute between soft fork vs hard fork, SegWit’s successful adoption is a victory for the soft forks.

Recommended: Differences Between Bitcoin Soft Forks and Hard Forks

What Was Segwit2x?

Some prominent Bitcoin miners supported several approaches to the scale issue inherent in the original Bitcoin protocol. To move forward, they came to what’s known as the “New York Agreement,” a plan to implement SegWit and do a hard fork of Bitcoin to increase the block size limit. This was “SegWit2X.”

However, Bitcoin’s developers didn’t endorse the plan and it never reached the consensus necessary for a successful hard fork. These developers have huge sway over the greater Bitcoin community and without their support, a fork wouldn’t have enough takers to challenge Bitcoin in its present set-up. By late 2017, SegWit2X had collapsed and early the next year, SegWit was fully operational on consumer cryptocurrency platforms like Coinbase. And major crypto wallets, the hardware and software products that allow for safe crypto storage, had signed on to the SegWit update.

The failure of SegWit2x shows that even large Bitcoin mining pools, groups of miners that run the hardware that creates new Bitcoin, don’t have total sway over the Bitcoin community and can’t singlehandedly dictate its direction – or its forks. Bitcoin miners have tended to prefer Bitcoin changes that would increase the block size as opposed to segregating out signatures, since that would bolster the fees they get from the network for processing blocks. But the Bitcoin community is more than just its miners, and so their opinion only means so much.

Should You Use SegWit?

While the Bitcoin scalability debate is hardly over, for the time being, Bitcoin itself remains in the driver’s seat in terms of usage and developer activity compared to its rivals and hard forks.

By early last year, at least two thirds of transactions used SegWit, indicating that the soft fork “works” for many in the Bitcoin community. By the end of 2020, one of the last exchanges to hold out, Binance, announced that it would support SegWit.

There are several benefits to using Segwit for crypto transactions, including lower transaction fees and faster transactions.

The Takeaway

SegWit was a major upgrade to the Bitcoin protocol, and one that has helped accelerate widespread adoption of the cryptocurrency in recent years.

You don’t need to be an expert in the details of Bitcoin protocol to start investing in cryptocurrency, however. You can get started by opening an account with the SoFi Invest® brokerage platform.

Photo credit: iStock/BartekSzewczyk


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.
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What Is Frontrunning?

Here’s Why You Don’t Want to Be an Investing Front Runner

Who wouldn’t want to be a frontrunner? In most instances, hearing the term “front running” may make you think that you’re doing something right. But when it comes to front running and trading? It’s a bit of a different situation.

That’s because front running, as it relates to trading and investing, involves insider information, and possibly illegal transactions. For that reason, it’s important for traders or investors of all stripes—from newbies to veterans—to be familiar with what front running means, what front running means to the Securities and Exchange Commission (SEC), and why you may want to avoid it as a part of your investing strategy.

What Is Front Running?

In short, front running trading means that an investor buys or sells a security (a stock, bond, etc.) based on advance, non-public knowledge or information that they believe will affect its stock price. That information is not yet public, giving the trader or investor an advantage over other traders, and the market at large.

But it’s easy to see how front running earned its moniker, too. Traders, making moves based on inside or non-public knowledge, are getting out ahead of a price movement—they’re running out in front of that movement, in a very literal sense.

This may sound familiar, or cause another term to spring to mind: Insider trading. In fact, front running is a form of insider trading and market manipulation (you don’t want to break the rules and have to deal with the fallout!)

Recommended: Everything You Need to Know About Insider Trading

If a trader has inside knowledge about a particular stock, and makes trades or changes their position based on that knowledge in order to profit based on their expectations derived from that knowledge, that’s generally considered a way of cheating the markets. It can not only involve stocks, but also derivatives, such as options or futures.

Front running is illegal, and forbidden by the SEC. It also runs afoul of the rules set forth by regulatory groups like the Financial Industry Regulatory Authority (FINRA). Of course, this doesn’t mean that individual traders or portfolio managers don’t take part in a little front running here and there, but generally speaking, it’s a practice that’s frowned upon in the financial industry.

A Front Running Example

Let’s run through a hypothetical example of how a common form of front running may work.

Say there’s a day trader, Theo, working for a brokerage firm, and they manage a number of client’s portfolios. One of Theo’s bigger clients calls up and asks them to place an order: The client wants to sell 200,000 shares of Firm X. Theo knows that this is a big order—big enough to affect Firm X’s stock price on the markets.

With the knowledge that a big order is soon to go through and cause Firm X’s stock price to fall, Theo takes a look at his own personal portfolio, sees that he owns some Firm X shares, and decides to sell them, anticipating the fall in value.

Theo makes the sale, then executes the client’s order (blurring the lines of the traditional payment for order flow). Then, Firm X’s stock price falls, and Theo saves himself some money, which he may use to invest in other stocks, or buy Firm X shares at a now-discounted price, and potentially, ultimately increasing his profits.

Theo would’ve broken the law in this scenario, breached his fiduciary duties to his client, and also acted unethically. While people do get caught front running in the real world, and it’s actually a fairly common practice in some stratums of the financial world.

Recommended: Understanding the Risks of Day Trading

Front Running in the Real World

There are many real-world examples of front running that have led to securities fraud, wire fraud, or other charges. Back in 2009, for instance, 14 Wall Street firms were hit with roughly $70 million in fines by the SEC for frontrunning.

“The SEC charged the specialist firms for violating their fundamental obligation to serve public customer orders over their own proprietary interests by ‘trading ahead’ of customer orders, or ‘interpositioning’ the firms’ proprietary accounts between customer orders,” an SEC release reads.

Further, research into the topic of front running finds that when people (or firms) have insider knowledge that could benefit them in the markets, they’re likely to use it.

As for another real-world example of front running, there was a case in 2011 involving a large global bank, and some foreign exchange traders who found themselves in hot water. The two traders became privy to a pending order from a client, made some moves to get ahead of it—front running!—and ended up making their company money .

There was big money involved, too. It was a $3.5 billion transaction, and by front running the trade, the traders were able to make more than $7 million. It’s not a happy ending, however, the people involved ended up sentenced to prison and ordered to pay hundreds of thousands of dollars in fines.

So, while front running does happen, there can be serious consequences if regulators catch wind of it.

Are There Times When Front Running is Okay?

Yes, actually. Index front running is not illegal, and is actually fairly common among active investors.

As many investors are aware, index funds track financial indexes, like the S&P 500 or Dow Jones Industrial Average. They’re funds designed to mirror the performance of an index, in other words. And since market indexes are really nothing more than big amalgamations of stocks, they change quite often. Companies are constantly swapped in and out of the S&P 500, for instance.

When that happens, it’s generally announced to the market, and public, before the swap actually takes place. If a company is being added to the S&P 500, that’s probably considered good news, and can make investors feel more confident in that company’s potential. Conversely, if a company is being dropped from an index, it may be a sign that things aren’t going so well.

That gives some traders an opening to take advantageous positions. Let’s say that an announcement is made that Firm X is being added to the Dow Jones Industrial Average, taking the place of another company. That’s big news for Firm X, and means that it’s likely Firm X’s stock price will go up.

Traders, if they have the right tools, may be able to quickly buy up Firm X shares the next day, and potentially, make a profit if things shake out as expected.

How is this different from regular front running? Because the information was available to the public—there was no secret, insider knowledge that helped traders gain an edge.

The Takeaway

Front running is probably not something that the average trader or investor is going to need to worry about. After all, how often do you find yourself face-to-face with confidential information that could move the markets? Probably not often. But it’s still helpful to know the frontrunner definition.

If you’re not necessarily looking to front-run any trades, but simply start putting your money in the market, the SoFi Invest® brokerage platform can help you do it. You can open an account with as little as $5 and use it to invest in stocks, exchange-traded funds, and cryptocurrency.

Photo credit: iStock/Drazen_


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
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