High Frequency Cheetahs
by Leo Melamed

In June of this year, CFTC Commissioner Chilton compared High Frequency Trading (HFT) to cheetahs. The metaphor is compelling. Cheetahs are the fastest four-legged animal. The "market cheetahs," he explained, are out there trying to scoop up micro dollars in milliseconds. "We need to do a better job of keeping up with the cheetahs," he proclaimed. I agree. But cheetahs also need protection. Among the unwritten CFTC commitments is to keep up with the market, in other words, its innovations and its evolution.

Commissioner Chilton, recognizes that American futures are a precious national asset. He knows futures began as a most efficient system for hedging agricultural products, helping provide our nation with food of the highest quality at cheap prices. They evolved by introducing financial instruments to risk-management techniques. It revolutionized the industry.

To its credit, the CFTC encouraged some of these momentous innovations. During its watch, the concept of "cash settlement," was introduced; a transformation from open outcry to electronic trade was undertaken; a restructure by exchanges from private organizations to public entities occurred. Consequently, this U.S. marketplace grew into an 82 trillion dollar industry. Clearly, a national resource.

While I cannot speak for securities markets, HFT in futures represent but one more evolutionary step in the life of this American asset. It involves the execution of complicated, algorithmic-based trades by powerful computers. Their principal objective is to take advantage of minute discrepancies in prices. Their high speed enables them to act on profitable trading opportunities faster than humans can do. It is part of the technological revolution which permeated every nook and cranny of our lives. It made everything faster. We are online with the world 24-7-365. We text, we twitter, we email, we Google, we Yahoo, we Facebook, we ipad, we iphone, we Blackberry, we Android. We cannot go back to the way it was.

Given the speed, size, and the complexity of their computer-based strategies, HFT has made it harder for the floor traders and affected the ability of the point-and-click crowd to make money. I am one of their victims. But their MO has been around since the dawn of markets: Buy low, sell high. When I began as a trader in the pork belly pit, I was as high a HFT as possible. My computer was in my head and it responded as fast as it could. There were others in the pit who were much slower. But there were also traders who were much faster. It never occurred to me to pass a law to cut them down to my speed.

Nor did I ever consider preventing a trader from mechanizing his or her trading model. During the trading-day, the options crowd would often receive updated pricing strategies generated somewhere in their back offices. It never occurred to me that this was somehow unfair. And I readily understood a trader's request to gain a trading booth closer to the pit. James Angel, Associate Professor of Finance at Georgetown University, recently said it made him shudder when he heard regulators asking, "Is it fair that people spend extra money to sit their computer right next to the stock exchange computer?" It showed, he said, an almost shocking ignorance of financial history.

There have been dozens of studies. They virtually all share the findings of the Bank for International Settlements (BIS) in its study, "High-frequency trading in the foreign exchange market," published in September of this year. The BIS concluded that by arbitraging away any discrepancies, HFTs narrow the spread between bid and offer, improve market liquidity, contribute to market efficiency, and lower trading costs to small investors. Similarly, there have been dozens of studies devoted to the cause of the "flash crash" of May 6, 2010. All have reached virtually the same conclusion: There is no evidence to support the assertion that HFT caused or contributed to the flash crash.

This is not to suggest the CFTC neglect its duty to keep up with the markets. My compliments to CFTC Commissioner O'Malia for his leadership in the formation of a Technology Advisory Committee. The committee has provided some excellent recommendations to strengthen electronic trade across both securities and futures markets by mandating adoption of credit controls, stop logic, order entry policies and restrictions, "Identifiers" for every end user, and the adoption of carefully calibrated market-wide circuit breakers.

Artificial intelligence is scary. But it won't go away. It is directed at deciphering intelligence and then installing it into a computer program. It can beat Garry Kasparov at chess; it can win at Jeopardy; it can do language translation; it can diagnose a patient; it can even kill terrorists. And in futures markets, it takes the form of HFT.

Our nation's futures markets are an outstanding example of "American Exceptionalism." They are a crucible for innovation and job creation. Their central-counterparty-clearing model has been mandated for much of the OTC market. They represent an American natural resource. It is the duty of the CFTC not only to keep up with the market cheetahs, but as Teddy Roosevelt admonished in a different context, they must treat our natural resources, "as assets which it must turn over to the next generation increased and not impaired in value."

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