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Financials

Some wary of SEC's high-frequency presumptions

* Order anticipation, momentum ignition in spotlight

* Changes are seen as possible, but nothing dramatic

NEW YORK, Feb 5 (Reuters) - Regulators considering new rules for U.S. stock markets should take care not to assume that certain types of high-frequency trading are harmful, speakers at a conference on algorithmic trading said on Friday.

The U.S. Securities and Exchange Commission’s appeal for public comment on equity market structure is largely balanced, speakers at the New York University conference said. Changes are likely, but none too dramatic, they said.

The SEC’s 74-page “concept release,” or comprehensive document on the subject, issued last month, asks whether the highly automated equity markets are fair to all investors, and whether they have the tools to protect their interests. [ID:nN13156728]

The SEC wants to know how long-term investors are affected by the specific strategies used by high-frequency traders -- those firms that use sophisticated algorithms to submit rapid-fire orders, earning profits on thin market imbalances.

Eric Hess, general counsel at Direct Edge, an alternative trading venue that accounts for about 10 percent of all U.S. equity trading, said he is concerned the regulator is playing up a conflict between long- and short-term investors.

“Constructing this release under the paradigm of this conflict skews the basis of analysis,” Hess said. “The long-term and short-term investors need each other.”

The SEC says the interests of these two types of investors may align, for example, when short-term investors dampen volatility, and may at times diverge, when the competition of short-term strategies are not useful for longer-term investors.

“Where the interests of long-term investors and short-term professional traders diverge, the Commission repeatedly has emphasized that its duty is to uphold the interests of long-term investors,” the regulator said in the document.

The SEC devoted 20 pages to high-frequency trading, which dominates equity volumes and has come under increased political and regulatory scrutiny amid alleged unfairness.

Ten of those pages deal with high-frequency strategies.

Michael Mendelson, director of global trading strategies at hedge fund AQR Capital Management in Greenwich, Connecticut, told the conference there is a presumption that so-called order anticipation strategies used to anticipate the direction of trading is not good for markets.

The SEC study “cites a paper that calls them ‘parasitic’ and says that they do not make prices more informative. I think that’s actually incorrect,” Mendelson said.

Order anticipation makes prices more informative because it quickly pushes prices in the appropriate direction, he said. “The market is more efficient when the market moves to the right price right away.”

Another so-called directional strategy that will get attention is “momentum ignition,” in which traders submit orders designed to induce upward or downward movement in a stock, said Direct Edge’s Hess.

Alexander Yavorsky, senior analyst at Moody’s Investors Service, told the conference he doesn’t expect “transformative changes to the market structure,” which heavily relies on high-frequency traders to make markets or facilitate smooth buying and selling.

“The definition of a market maker has changed, whether people like that or not, over the last 10 years as markets became more electronic and faster,” Yavorsky said.

Reporting by Herbert Lash and Jonathan Spicer; Editing by Richard Chang

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