Sense on Cents

High frequency trading activity has become a very hot topic both on and off Wall Street. My trading instincts tell me that this activity is not productive for the long term health and well being of the market. I have referenced the work of Joe Saluzzi and his colleagues at Themis Trading in making the case for the prosecution.

In an attempt to present a case for the defense, I searched and found commentary written by Sang Lee, managing partner at Aite Group. Lee recently wrote for Advanced Trading, In Defense of the High Frequency Trading Community:

Various potential regulations, including the reinstatement of the uptick rule and transaction tax directly threaten the business model of the high frequency trading community.

Sense on Cents counterpoint: The uptick rule required short sellers of stock to only transact at a price higher than the previous trade. Our friendly Investing Primer, Investopedia, informs us:

This rule was introduced in the Securities Exchange Act of 1934 as Rule 10a-1 and was implemented in 1938. The uptick rule prevents short sellers from adding to the downward momentum when the price of an asset is already experiencing sharp declines.

The rule worked fabulously for almost 70 years before being discontinued in July 2007. It was discontinued in an attempt to promote trading volume on the exchanges and in turn increased fees.

Sang Lee writes further in making his point:

In recent years, growth of alternative electronic trading venues has been driven by a multitude of factors: the introduction of decimalization; the adoption of FIX as the main protocol for electronic communication; the availability of technology for developing market infrastructure conducive for electronic trading; the rapid adoption of electronic trading; the adoption of algorithmic trading; and the availability of co-location services.

Sense on Cents counterpoint: Fairly obvious with all of the technological advancements that we are not looking at your grandfather’s “buying 100 shares of IBM.” Modern day trading activity is both fast paced and high energy. Little wonder why it has become so much more driven by technical analysis than fundamental valuations. (more…)