How Queue Position Creates Expected Value in Penny Jumping
Summary
The document explains why a trader who steps ahead of a large displayed buy order may have value even when a rising market leaves the trader unfilled. It separates the upward-price scenario into three cases: the order fills before prices rise, fills only partly, or receives no fill. The first two cases can benefit from a favorable fill followed by upward movement, while the unfilled order may still gain value from being at the front of the bid queue.
The explanation is conceptual rather than empirical: it asserts that expected value declines across those outcomes but remains positive in the no-fill case when queue priority is valuable and the tick size is meaningful. It does not quantify probabilities, costs, adverse selection, or the conditions needed for the expectation to be positive. The example therefore clarifies the proposed mechanism, but does not establish that penny jumping is profitable in every market or order-book setting.
Key ideas
- A rising price does not imply a single outcome for an order placed ahead of a large bid.
- A trader may receive a full fill, a partial fill, or no fill before the price rises.
- Queue priority can have expected value even when the order is never executed.
- The argument depends on queue position being valuable and tick size being sufficiently meaningful.
Tags
Full text
# Penny jumping in the direction of the price # Penny jumping in the direction of the price Reading through examples of legal front running, I'm struggling to understand how "penny jumping" (http://www.wikinvest.com/wiki/Front-running) can be profitable. Suppose stock ABC is trading at a spread of \$50.1 - \$50.9 and trader Alice has placed a very large day buy order at the \$50.1 level. Trader Bob who is supposed to profit and limit his risk is placing an order at \$50.2, one tick up. Now your typical description would say something like: "if ABC's price rises above \$50.2, Bob will profit, but if it doesn't he'll be able to sell for \$50.1 as part of Alice's large limit order." Down: This is a buy order, so if the price goes down it is because there is sell pressure, and sellers are eventually crossing the spread. When Bob's buy order has traded he can still scratch trade by selling back against the impenetrable $50.1 bid level, and he didn't lose much. His risk is indeed limited. Up: (Here's what I don't understand.) If the price goes up it means more bidders are joining the queue on the bid side pushing the levels up above \$50.2 where Bob's order resides. Bob's order will not get done at all - where's the profit here? We'll simply discover by the end of the day from the average close price that "ABC went up". ## Answer by user2763361 (score 1, accepted) https://quant.stackexchange.com/a/9894 In the Up scenario, there is not one possible outcome. There are multiple possible outcomes within Up. This could be (i) fill and price goes up, (ii) partial fill and price goes up, (iii) no fill prices goes up. All three outcomes have positive value in expectation, with that value descending as we go from (i) to (iii). The third outcome is profitable in expectation as well because we have front-queue position which is very valuable assuming the tick size isn't too small, which it doesn't seem it be if that trader is placing 10 cents above the inside.
Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.