Accounting is the language of business and investing. Beneath this fact, there is the world of math by which stock averages are calculated, curves are drawn, and analyses and charts are compiled. Some types of investing, and the math that supports them, are at a level of complexity that's beyond what the average investor could do quickly in his or her head. As such, we depend on machines to do most of the work. Read on as we follow the rise of these computing machines and their impact on investing's history.
There is no doubt that calculating, as in the tallying of numbers, has been around far longer than the archaeological evidence can prove. Bones, stones and anything else used to tally don't always stand out as much as clay pots and fertility idols when archaeologists are digging into the past. It is likely that the ancient Egyptians were using early forms of the abacus to calculate taxes around 3000 B.C. By the 1300s, shopkeepers and moneylenders from Japan to England were using the abacus to track sales and calculate interest. The abacus was made up of beads on parallel wires that represented units of one, 10, 100, 1,000, etc. This allowed people to add or subtract large numbers without losing their place. This means that for almost 5,000 years the abacus was the best humanity could do.
Computing Without Numbers
It is important to note that as late as 1150, business in Europe was taking place in Roman numerals rather than the numbers we know today. Europeans didn't enter the world of Arab numerals until the translation of ancient mathematic texts were widely read. The printing press spread this literature around, as well as rediscovered Greek texts on geometry. This spurred European intellectuals to try their hand at advancing the field of computation. (Keep reading about how the modern investing world formed in From The Printing Press To The Internet and The Birth Of Stock Exchanges.)
The Scotsman, John Napier, discovered logarithms in 1614. Perhaps the greatest leap forward in math, this innovation gave bookkeepers a badly needed tool: the ability to multiply and divide. This sped up the work of shopkeepers and bookkeepers, freeing them to conduct more business. Napier created the precursor to a slide rule that was called, "Napier's Bones". It could help a person multiply, divide and extract both squared and cubed roots. The combination of logarithms with the previous introduction of decimals and Arab numerals made it possible to calculate percentages instead of speaking purely in fractions. This changed the language of taxes and loan terms.
Blaise Pascal, the French philosopher, invented a calculating machine in 1624. It was called the "Pascaline", and it was the first calculator that required almost no mathematical skill to operate. It was still being used in the 1900s, when the electronic calculator finally condemned it to museums in the 1960s. The Pascaline helped spur business onward by making arithmetic a mechanical process instead of a mental one. Specialized bookkeepers could hire less-experienced people to do mechanical calculations and handle more clients as a result.
The Analytical Engine
Sir Charles Babbage started down the road that led to computers in the early 1800s. He made a mechanical device that could carry out mathematical calculations and print out an answer. It had an input device, storage, a processor, a control unit and an output device, all of which became basic components of general purpose computers. In 1884, Herman Hollerith patented the encoding of data using punch cards and the corresponding reader, and started the Tabulating Machine Company, which would one day become IBM (NYSE:IBM).
During the WWI and WWII, the armies demanded more computing power to analyze and process the mountains of information coming in. Because the military-industrial complex controlled a large portion of the world's capital during the war, it got what it wanted. Electronic and digital computers emerged in rapid succession, starting with the Atanasoff-Berry Computer (ABC) and ending with Electrical Numerical Integrator and Calculator (ENIAC). ENIAC was designed to set firing schedules for weapons in various conditions. The creators of ENIAC formed a private company that was bought out by the Remington Rand Corporation (makers of typewriters, razors and guns) and renamed UNIVAC.
With the introduction of transistors in 1940s, the UNIVAC I became the first computer for sale. The first one went to the Census Bureau, which was still using one of Herman Hollerith's tabulating machines, and the second went to General Electric. UNIVAC I was the only computer until IBM came up with the IBM 650 in 1956. From there, the computer race began, and the machines steadily became smaller, faster and more affordable.
Software Meets the Market
Prior to the introduction of computers, Wall Street was depending on calculators and people to make an understandable picture of the market. There were indexes and analysts, but the things they could say about the figures they quoted were limited by human capacity and the time it took to run the figures. Computers and data processing ushered in several innovations at once: Electronic trading made low-cost brokerages and the Nasdaq possible, processing speeds meant more accurate data at a faster pace, and software made technical analysis available to all investors, quickly leading to program trading. (For more insight, read The Power Of Program Trades.)
Program trading, which depends on the algorithms discovered by Napier hundreds of years earlier, became a powerful force on Wall Street. Computers running software that blindly traded shares to take advantage of arbitrage and protect portfolios with layers of stop-loss orders became popular with all types of investors, from institutional to individual. Computers became automated investors - like the Pascaline, it took little skill to operate one. This freed up brokers and investors to appreciate the finer things in life.
In 1987, program trading bit the hands that fed it. A minor hiccup in the market started a domino effect in computers with stop-loss orders, which is now referred to as Black Monday. As more computers blindly sold, prices fell further and more stop-loss orders were triggered. The avalanche continued until the exchanges locked out the computers and then Chairman of the Federal Reserve, Alan Greenspan stepped in. Today there are circuit breakers that prevent program trading from doing a repeat performance. (Keep reading about the Fed in The Federal Reserve and A Farewell To Alan Greenspan.)
Conclusion: The Dangers of a Beautiful Thing
The small, powerful computers that drive business today started as beads strung on a wire by someone sitting in the shade of a pyramid. With the right program, you can come up with the same figures those Wall Street analysts ponder day in and day out. The computer is, however, still just a tool; as such, it is only useful for investors who don't leave it to rust.