There are definitely two camps when it comes to high-frequency trading. Some believe the practice represents significant risk to the capital markets. Others think it is a huge benefit to the markets. I think we all agree we need to tread carefully as the implications continue to emerge. 

Technology has for the most been a huge factor keeping the U.S. capital markets competitive. And in some ways, high-frequency (high-frequency trading news) is a continuation of the march of beneficial technology. The defense of this form of trading typically starts with added liquidity. We've all heard how high-frequency trading now accounts for up to 70 percent of equity volume, which is pretty amazing. "High-frequency trading creates opportunities for long-term investors by providing more liquidity," said one defender, as noted by Wall Street & Technology. That extra liquidity provides even more narrowed spreads for long-term investors, which means better deals for investors. "During the turbulent fourth quarter of 2008, it was high-frequency traders that stepped up and provided liquidity," this experts argued. Others would take issue with that. 

One way to approach the issue is to look at the movement in light of longer-term movements toward more efficient markets, as conventionally measured anyway. Over the last 15 years, we saw the move toward decimalization and order handling rules and other moves aimed at lowering costs to individual investors. The provocative thesis of Grant Thornton's David Weild and Edward Kim is that this effort, contrary to conventional wisdom, has been devastating to the markets. It has "had the unintended consequence of stripping economic support for the value components (quality sell-side research, capital commitment and sales) that are needed to support markets, especially for smaller capitalization companies." 

The result: The U.S. listed markets are in secular decline. Since 1991, the number of exchange-listed companies in the U.S. has fallen 22 percent. Since 1997, the peak year,  the number has fallen by nearly 40 percent. Most of this occurred in prosperous times, when you would expect the numbers to grow. Grant calls this "The Great Depression in Listings." 

In this context, is high-frequency trading, which moves the long-term trend toward more technology to the extreme, a good thing? 

Those who buy the Weild-Kim thesis might argue that this trading simply will fuel more of the same. Certainly, this kind of trading doesn't seem to be anything that will widen spreads (and we're not saying that's a good thing). We've seen a widening lately, but that had nothing to do with the rise of this form of trading. The rise of high-frequency trading is in fact an acknowledgement of permanent razor-thin spreads. The only way to make money is on volume, millions of trades at a time. 

At the same time, high-frequency traders do not really traffic in thinly-traded issues or in small-cap issues. And that is where most of the damage to the markets has occurred. We've seen some trading of Citigroup and the likes, but these aren't your normal sub-$5 stocks. It's clear that the focus of high-frequency trading is on large-cap stocks. But is that simply a reflection--rather than a cause--of the current reality? And the liquidity may indeed be a good thing for the large-cap market. There may be other benefits. A new lobbying group has been formed, and we may hear a more robust defense soon. - Jim