For more than 200 years, the buying and selling of stocks did not change much. Stock trading typically took place at a physical location, usually at a stock exchange, and during a specific period of time, or trading hours. The market was open during trading hours and closed at all other times. Today, it's becoming hard to imagine that the opportunity to invest was ever limited by time and space.
It's no exaggeration to say that things are changing at the speed of light. It's the present and future of investing - and it's happening as you read this article. Most trading will soon be automated, 24 hours a day, seven days a week, 365 days a year. Where? In cyberspace, and that means anywhere and everywhere. When this occurs, trading will become an instantaneous electronic exchange of information between buyers and sellers, anywhere in the world at any time. In this article, we'll introduce you to the where investing and trading technology is headed and what it means for investors.
Being Digital - Now
According to a 2006 research report entitled "Top 10 Strategic IT Initiatives in Global Capital Markets for 2006: Automation Rules" from the industry consulting firm Financial Insights, creating new efficiencies is not new to the capital markets arena. What is new is the accelerated pace at which change is occurring, driven by regulatory, technological and economic factors.
The internet has caused major shifts in investor behavior and expectations. No other sector of the world's economy has been affected by the rapid development of e-commerce as much as the securities industry. Accordingly, investors want the instantaneous trading and access-to-information capabilities that only online technologies can provide. Worldwide, markets and regulators have responded quickly to meet their needs.
Financial Insights' report notes that while the technology that created direct market access has automated the world's stock markets, these innovations are spreading to other asset classes. "All systems will need to be streamlined and stress-tested as trading velocities increase," the report said.
Investors, traders and regulators are receiving a crash course in the lexicon of electronic commerce: algorithmic trading, hybrid markets, electronic communication networks - and many more to come.
ECNs and More
Electronic communications networks (ECNs) and electronic stock exchanges are making the most impact on investors. An ECN is an automated system for trading stocks away from a stock exchange. ECNs were authorized in 1998, when Congress and the Securities and Exchange Commission (SEC) wanted to increase industry competition for automated trading in over the counter (OTC) markets. ECNs also provide an SEC-authorized venue for after-hours trading. (To learn more, see the Electronic Trading tutorial and Direct Access Trading Systems.)
ECNs typically act as passive order-matching systems, matching buy and sell orders that have the same prices for the same number of shares. Unlike stock exchanges, ECNs do not employ specialists or market-makers to coordinate trades. Some of the best-known ECNs operating today are Bloomberg's Tradebook, the Nasdaq-owned Instinet and BRUT, and Archipelago Exchange (formerly known as ArcaEx and the Pacific Exchange that the New York Stock Exchange acquired in April of 2005).
ECNs are attracting a rapidly rising trading volume, with some estimates suggesting that they now trade more than 60% of over-the-counter volume. A 2005 report entitled "Regulation NMS: One Rule to Bind Them All" by Celent, a financial industry consulting firm, forecasted that ECNs will continue their dominance in OTC stocks due to new technology initiatives, and because the U.S.'s Regulation NMS (a new stock market regulatory structure) will permit ECNs to increase their trading volume of exchange-listed stocks.
Still, it might be a bit early to predict the demise of stock exchanges, which are developing automated trading capabilities of their own right beside their traditional open-outcry system based on human specialists and market-makers. (For more insight, see Markets Demystified.)
Many investors believe that the passive matching of buyers and sellers through automated trading cannot match a stock exchange's ability to provide a means for finding more accurate bid and offer prices. Exchanges continuously attract large numbers of prospective buyers and sellers who provide a wide range of bids and offers. Proponents of stock exchanges believe that this creates a more reliable price discovery mechanism than passive order matching through an ECN.
Meeting the growing demand for faster trading and access to investment information will continue to create new and more advanced electronic trading venues. The New York Stock Exchange's merger with Archipelago Holdings has changed the NYSE into a "hybrid" stock market, allowing investors to place orders through NYSE Arca, its new automated trading platform or its traditional floor brokers. Large or complex orders will continue to be routed through floor traders. Brokers will be able to buy and sell shares of NYSE-listed stocks electronically, in quantities of up to one million shares. Orders are expected to take less than one second to execute, down from an average of nine seconds.
Some business moves will cross international boundaries. The NYSE continues to expand its operations; in June 2006 it agreed to merge with Euronext, a pan-European stock exchange. When the merger is completed, the NYSE will become the first global stock exchange. Not to be outdone, Nasdaq has acquired a substantial portion of the London Stock Exchange, expected to further strengthen Nasdaq's dominant position in the OTC markets.
More Than a Revolution
The development and widespread adoption of electronic trading venues represents far more than a fast new way to trade stocks. These technologies give companies listed on the new electronic markets access to pools of capital all over the world. Investors will be able to buy and sell shares of international companies as easily as trading in their local markets. This is far more than a technological revolution. The potential worldwide impact of more mobile pools of capital could have far-reaching and inestimable economic benefits.