Back in high school I once took a class called “Death and Dying”. There I learned the works of Elisabeth Kubler-Ross and her “Five Stages of Grief”. These stages are Denial, Anger, Bargaining, Depression, and Acceptance. I have always thought markets went through some similar stages. The definitions are fairly close between the Investing and the Kubler-Ross versions. Except for #5, Investor Acceptance, defined as “where the strategy is adopted, copied endlessly, and mercilessly beaten into the ground until it breaks by the Street.”
Are we at that stage with high frequency trading strategies now that Michael Lewis’ recent interview on 60 Minutes brought this strategy to the mainstream and government organizations are investigating?
On one side of the coin it likely will take a while, if at all, for investor’s perceptions to change, Washington to hold hearings on the matter, and regulatory bodies to take action. Even then, there is a chance that the status quo won’t change. Many derivative strategies and concepts that were reviewed during the financial crisis a couple of years ago survived because there is a legitimate use of them in the marketplace and that investors may actually benefit as a whole. There are similar arguments for high frequency trading, usually invoking increased market liquidity and tighter spreads. Plus the pace of financial innovation often outstrips the ability of regulators to modify behaviors. Why should high frequency trading be any different?
However, eventually investors do come up with their own successful strategies to counteract something like high frequency trading. Perhaps we might even see a comeback of good old-fashioned block trading. Plus since other countries have taken measures to regulate high frequency trading, there is a precedent. Finally, regulators can move more swiftly and take sweeping actions that vastly impact financial markets more than investors anticipate, such as with Dodd-Frank and reforms such as Sarbanes-Oxley and Reg FD several years earlier in the wake of the internet bubble.
Is high frequency trading at #5 on the investor’s version of the Kubler-Ross scale or are we still at an earlier stage? What do you think? Has the Michael Lewis interview brought high frequency trading to the fore and that investors will find ways to counteract it and regulators will eventually dismantle the strategy, or are we just at the beginning of a new revolution in algorithmic trading and artificial intelligence?