CFTC Economist Theorizes High-Frequency Traders Can Tame Prices

An economist at the Commodity Futures Trading Commission is trying to determine if some high-frequency trading strategies in futures contracts tied to the Standard & Poor's 500 index may moderate price swings like those seen on May 6.

CFTC economist Andrei Kirilenko is working with California Institute of Technology mathematical finance professor Jaksa Cvitanic, and the two are looking at a trading strategy known as "sniping," which entails quickly submitting buy and sell orders of a certain size and then immediately cancelling them if they cannot be executed right away. They are theorizing that this trading strategy actually moderates price swings.

Cvitanic said in an interview that they began the study in June 2009, but they haven't yet begun to analyze the trading data to see if the theory holds true. Kirilenko couldn't be reached for comment.

The two economists published their theoretical model on high-frequency trading in a March working paper. The study is still in its early stages. But the outcome could be important for regulators to consider as they examine the reasons why the Dow Jones Industrial Average fell nearly 1,000 points on May 6 before quickly rebounding. Regulators are studying, among other things, what role, if any, high-frequency traders who execute transactions at lightning speeds may have played.

CFTC Commissioner Scott O'Malia said Wednesday that Kirilenko will be asked to discuss this paper and others on which he's working in July at the first meeting of a new technology advisory committee. The CFTC advisory panel of experts will study high-frequency trading, co-location services and other technology issues.

Proprietary trading firms have become an increasingly larger percentage of trading volume on equities and derivatives exchanges. A report released by the CFTC and Securities and Exchange Commission this week suggested that the May 6 price volatility may have been exacerbated after some electronic liquidity providers shut down or scaled back trading activity.

CME Group (CME), which lists the E-mini futures contract tied to the S&P 500, has said that trading of the E-mini didn't spark the massive sell-off in the equities markets and that high-frequency traders were not to blame. High-frequency traders make up about 36% of all volume across CME's various trading platforms and 40% on the E-mini, according to CME's Executive Chairman Terry Duffy.

CFTC Chairman Gary Gensler said in March his agency plans to draft a proposal around co-location services, which allow traders to place their computers in the same building as the trading platform.

The SEC, meanwhile, is looking at high-frequency trading as part of a much broader review of market structure issues including co-location, dark pools and flash orders, among other things.

-By Sarah N. Lynch, Dow Jones Newswires, 202-862-6634; sarah.lynch@dowjones.com

(Jacob Bunge contributed to this article.)

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