Economy

Stock Trading Has Accelerated Beyond Our Control

Published

10 years ago

March 20, 2015

Contributor

The speed and technology used to trade stocks has changed enormously and now regulators are looking at ways to dial trading speed back down and bring more humans back into the market.

This article was originally published on Timeline.

The Brief

The Nasdaq Composite, an index of mostly tech stocks, reached 5,000 in the first week of March, the highest since the dot-com bubble in 2000.

But since most trades are automated, we’re basically watching our technology trade our technology stocks. This situation is the endpoint of investors’ eternal, tech-fueled race to gain knowledge before others. Being the first to know has always given traders an edge, whether their access to market data was limited by the speed of ponies or the speed of light. Now regulators are looking at ways to dial trading speed back down, to bring more humans back into the market.

1790s – High-speed traders try to outrun public knowledge

When the new US government decided to buy back the debt of individual states in 1790, speculators quickly dispatched traders on clipper ships to purchase the bonds before word got out and the prices rose.

After the US Postal Service was established in 1792, traders put private express stagecoaches on the same routes, trying to beat the mail. The Postal Service, in turn, tried to beat the traders.

Newspapers also wanted to beat the traders. When the modern paper industry emerged in the early 1800s, many publishers hoped to inform the public so they wouldn’t fall prey to speculators who knew more.

1840s – Optical telegraph sends data between cities

To beat the public mails on high-speed horses, Philadelphia broker William Bridges set up a private semaphore communication system between New York and Philadelphia. It consisted of a series of signal stations on hilltops, each visible to its neighbors by telescope. Each station had a pole and a set of coded boards that the signal operators would use to display their message to the next station down the line.

The system conveyed stock information from New York to in Philadelphia in less than 30 minutes, for the sole benefit of Bridges and his backers.

1844 – Telegraphs and tickers beat all couriers

Long-distance telegraph beat any pony or pigeon by sending messages over wires as fast as an operator could key them in. Its inventor, Samuel Morse, didn’t want speculators abusing the medium and advocated it as a semipublic utility. But the wires were built out privately by Western Union, which wound up making nearly 90% of its revenue from speculators and racetrack gamblers.

In 1869, Thomas Edison invented the ticker, a telegraph receiver that translates Morse Code into type characters printed on paper tape. Stock markets offered subscriptions to live trade prices via the ticker. This format lives on as the crawl at the bottom of today’s financial TV broadcasts.

1878 – Phones send fast word for a century

Stock tickers remained useful as an ongoing live feed of stock price updates. But after the telephone arrived, it reigned as the fastest way for traders to communicate their hot tips.

The first phone at the New York Stock Exchange was installed in 1878, two years after the device was invented. Investors began barking orders into phones, and the image persisted into the 1987 movie Wall Street, in which predatory investor character Gordon Gekko uses an early Motorola cellphone.

1980s – Computers trade on their own and quickly take over

In 1971, the newly created Nasdaq exchange executed trades submitted electronically rather than by phone. Other stock exchanges followed. In the 1980s traders developed software that submitted market ordersautomatically, for example if a stock reached specific price. Investing became hackable, and program trading soon began to move whole markets, contributing to the Black Monday crash on October 19, 1987.

The program-driven market inspired an arms race seeking faster and more sophisticated algorithms and hardware. If you could write software that anticipated how other’ trading systems would behave, you could get there first and make a profit.

2000s – Shorter fiber-optic runs save microseconds

High-frequency trading (HFT) became a new recipe for harvesting money from Wall Street. They key was deploying smarter programmers and more powerful computers to trade faster than the competition. In 2000, stocks began trading at penny differences rather than fractions of a dollar. This turbo-charged HFT by letting systems shave profits more frequently, in smaller increments.

But light only travels so fast through fiber-optic cable, and it takes a few milliseconds for Wall Street price info to get to Chicago. So a financial “location services” industry grew to install trading machines physically closer to stock exchange servers in New York and New Jersey, and connect them via shorter top-of-the-line cables.

2015 – Strategies for limiting high-frequency trading

After the 2008 financial crisis and the US markets’ “flash crash” in May 2010, people looked for ways to slow trading down. One approach is a small financial transaction tax (FTT) that’s expensive for computers that make zillions of trades per second, but cheap enough not to discourage human decisions. The EU is weighing this for 2016. Similar bills came before the US Congress in 2011 but never came to a vote.

High-frequency trading brings more money to larger businesses, but smaller companies depend on research-based investment. To level the playing field, a Security and Exchange Commission pilot program will make small stocks trade at intervals of 5 cents rather than 1 cent, startingin May. This slows trading by reducing the possible range of prices.

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Photo: Ken Teegardin via Flickr