Technology and Buy Side Impact

Reg NMS market structure rules consolidated in 2005 to promote the national market system have instead paved the way for an unforeseen and unfortunate result – the rise in machine trading and the move away from more traditional capital facilitation trading.
And we’re witnessing those results more than ever today.
Prior to 2005, buy-side firms invested in quality execution by hiring experienced traders who were as adept and knowledgeable of trading as their sell-side counterparts. Money managers set up their trading desks in sectors to mirror sell-side trading desks.
Buy-side traders in the pre-Reg NMS era were extensions of their fund managers and were able to react effectively and opportunistically to changing market conditions. They “traded” their orders based on tactical perspectives and their personal experience by using multiple trading strategies. They were measured on their ability to execute at the highest level with the long-term goals of the funds traded taken into account.
Then Reg NMS changed all that by revamping the market structure and promoting the rise of machine trading. Orders were now executed mostly through electronic markets and the human intervention for pricing discovery of trade execution was de-emphasized. Algorithms that mirrored the VWAP became the dominant strategy to execute orders, and buy-side traders were using these algorithms to execute orders.
Traders no longer traded order flow; they managed it through the machines. They stopped being opportunistic and trading aggressively during times of price displacement. Instead, they would work orders over the day through their machines and then simply settle for their average price execution. I call this “the dumbing down effect.”
Read more…TabbFORUM: “The Dumbing Down of the Buy-side”