We analyze the dynamics of the S&P 500 futures price, finding both short- and long-run effects of order flow on price. While price moves strongly with the order flow in the short-run, the long-run impact is slightly negative, attributable to costly slippage from a hedging propensity in futures markets. We find strong evidence of a state dependence in the relation between price and order flow, using both volume and floor trader income measures as states. We also find that both the long- and short-run impacts of order flow are greater when dealer income is higher.

Recent evidence indicates irrational behavior among retail investors. They hold onto losses and sell winners in a manner consistent with the disposition effect. Market professionals often use the term “discipline” to indicate trading strategies that minimize potential behavioral influences. We investigate the nature of trading discipline and whether professional traders are able to avoid the costly irrational behaviors found in retail populations. The full-time traders in our sample hold onto losses significantly longer than gains, but we find no evidence of costs associated with this behavior. The successful floor futures traders in our sample exhibit trading behavior characterized as rational and disciplined. Moreover, measures of relative trading discipline have predictive power for subsequent trading success.

[We use a cost of carry model with nonzero transaction costs to motivate estimation of a nonlinear dynamic relationship between the S&P 500 futures and cash indexes. Discontinuous arbitrage suggests that a threshold error correction mechanism may characterize many aspects of the relationship between the futures and cash indexes. We use minute-by-minute data on the S&P 500 futures and cash indexes. The results indicate that nonlinear dynamics are important and related to arbitrage, and suggest that arbitrage is associated with more rapid convergence of the basis to the cost of carry than would be indicated by a linear model.]

Peter R. Locke, Asani Sarkar, Lifan Wu, Market Liquidity and Trader Welfare in Multiple Dealer Markets: Evidence from Dual Trading Restrictions, The Journal of Financial and Quantitative Analysis, Vol. 34, No. 1 (Mar., 1999), pp. 57-88