The History of Automatic Stock Trading
The age of computers prompted new industries, changed old ones and altered our lives. Perhaps in no other industry has the advent of computers made an impact and created an entire new way of doing business than in the financial industry. Automatic everything dominates the business today.
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The Beginning of Automated Stock Trading
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The first computers, unveiled after World War II, were large behemoths that took up huge rooms and took time to process advanced mathematical problems. Technology quickly advanced, and computers got smaller and faster with more memory capacity. The securities industry officially adopted the new technology on December 20, 1966 when the New York Stock Exchange (NYSE) automated quote data and the transmission of trade information from the trading floor. The securities industry would never be the same.
ECNs
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The first securities ECN -- electronic communications network -- was Instinet, started in 1960. It was the first computer-based system where securities data could be input and trades initiated. The system was initially available only to professional traders such as market specialists and market makers. Additional ECNs opened in the following decades. Two economists, William Christie and Paul Schultz, carried out a study of ECNs in 1994. They discovered that market makers were artificially maintaining wider spreads -- the difference between bid and ask prices for a stock - than was necessary. The U.S. Department of Justice investigated, and the Securities and Exchange Commission (SEC) passed new rules regulating ECNs. The SEC's goal was to make trading as transparent as possible.
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Stock Exchange Automation Continues
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The Nasdaq, the first totally automated stock exchange, opened in 1971. The exchange originally listed 2,500 companies and traded 2.2 billion shares. The older, established NYSE continued its technology upgrades. The Securities Industry Automation Corporation, providing automation and data processing services, was established in 1972. The DOT system (designated order turnaround system) was instituted in 1976 to automatically route small orders to the exchange. Technology advances continued throughout the 1980s, 1990s and into the 2000s. By 1996 online brokerages and online trading were gaining in popularity. Computer trading promised low commissions and allowed the account holder to maintain control over his portfolio.
New SEC Regulations
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The SEC mandated the Regulation National Market System (Reg NMS) in 2005. This was part of the SEC's continuing effort to make stock trading as automatic and transparent as possible. The system introduced a consolidated quote tape for all exchanges and mandated that trades be executed at the best possible price. The rules theoretically provided equal access to trade data to all market players. ECNs morphed into ATCs (automatic trading centers), fully electronic trading centers. The largest ECNs were Island, Instinet and Archipelago. Instinet was purchased by Nasdaq; the NYSE bought Archipelago, and Reuters acquired Island.
Automatic Trading as the Industry Standard
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Automatic trading is also known as algorithmic trading, black box or robo trading. Software compiles data and, as trading occurs throughout the day, has the ability to originate and process trades. Programs are used by large institutional traders such as pension funds, mutual funds and hedge funds. The algorithmic software and the traders who use them specialize in high-frequency, high-speed trading. Traders input information based on a variety of criteria, and the software program triggers trades when a pre-determined data point is reached, such as a price to buy or sell a particular security. Automatic algorithmic trading is used in a variety of different securities markets, including stocks, options, commodities and the Forex currency markets.
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