It’s interesting that the debate around whether high frequency trading is a good thing or a bad thing for the markets and whether or not it benefits investors as a whole continues to rage in the blogosphere.

In the blue corner, we have Cameron Smith, General Counsel of Quantlab Financial, who recently wrote a very articulate, well-reasoned article in defence of high frequency trading on the Traders Magazine website. You can read his article here.

In the red corner, we have Sal Arnuk from Themis Trading, who put together a spirited response to Smith’s arguments in his influential Themis Trading blog, which you can read here.

I would encourage you to read both articles and come to your own conclusions. They both argue their points well. For anyone who wants to gain a better understanding of high frequency trading and to understand why it is a controversial topic, reading both articles will provide you with a good education.

Any sort of debate like this, out in the open, is a positive thing in my book. Too many misinformed articles seem to be appearing in the press these days about high frequency traders being the big, bad bogeymen who’s activities will kill the markets. That’s one of the reasons I like reading the Themis Trading blog. These guys are traders who know what they are talking about because they deal with the effects of high frequency trading day in, day out.

Clearly, Arnuk and his partner at Themis, Joe Saluzzi, are not in favour of high frequency trading, but at least they are well-informed and come up with some good arguments and innovative ideas (for example their cancellation tax idea, which is starting to pick up support) for ways of dealing with overly predatory practices.

In a nutshell, the arguments from both sides are as follows.

1) Smith says that high frequency traders add liquidity to the markets. Arnuk counters that they only add liquidity to the top 100 stocks or so, and that smaller cap stocks are actually suffering from wider spreads and greater volatility as a result of high frequency trading. Both are true, so we’ll call this round a draw.

2) To Smith’s argument that high frequency trading aids price discovery, Arnuk argues that HFT can actually have the opposite effect, because high frequency trading is essentially price agnostic. Maybe I’m a little obtuse, but I’m not sure that I follow Arnuk’s argument on this one, so I’ll give this one to Smith.

3) Regarding Smith’s claim that high frequency trading lowers transaction costs, Arnuk argues that the full costs of the transaction are not taken into account. So you might think you are paying $10 per trade with a narrower spread as a retail investor, but that is not the true cost of the transaction. Again, they are both right. The growth of automated and high frequency trading has significantly lowered transaction costs, but retail investors are generally not fully aware of the costs of doing business in these automated markets. So we’ll call this one a draw too.

4) Smith discusses in his post how high frequency trading is actually an evolution of traditional market making. Arnuk quite correctly states that this is not the case because market makers are obliged to provide a two-way quote in all circumstances, whereas high-frequency traders do no such thing. So Arnuk definitely wins round 4.

So we’re even stevens at the moment and it all hangs on the last round, which asks the big question. Is high frequency trading beneficial or harmful to investors?

Seconds out, round five.

5) Smith makes some excellent points in his article about how the growth of high frequency trading, together with the structure of the US equities markets has led to a fair, transparent and efficient environment that is beneficial to all. Arnuk counters that the current structure of the markets is neither fair, transparent or efficient. Both provide examples to back up their claims and there is logic and truth on both sides of the argument.

So I’m going to wimp out here, call it a draw and encourage you to check out their articles about high frequency trading for yourself. Now excuse me while I make myself more comfortable sitting on this fence….