#331 The Impact Of Computer Trading

What is Computer Trading?

The reason we wanted to cover computer trading and give you a little bit of what its background is, why we have it and does it help or hurt markets, is because we’ve gotten a lot of questions from clients about it. There’s a general anecdotal feeling out there that perhaps the level of computer trading that we do in markets and the speed exacerbates some volatility. Computer trading in financial markets is also known as program trading or algorithmic trading. In the financial press you’ll see it’s also called algo trading and simply means the use of computers to be faster and more efficient in executing trades in the financial market. The anecdotal sense is it’s a large black box that creates a lot more volatility and lack of control in which it does not do. It has probably exacerbated moves from time to time however, we wanted to give you a little bit of history of why we have it.

The Rise of The Institutional Investor

If you look at financial markets prior to 1960 they were built around the individual investor ordering stock and such from a broker who then would turn around and execute that order on the New York Stock Exchange. The reason we started to have computer trading is that in the late 1960s there was a rise in what we would call the institutional investor such as a big bank or a large Insurance company. It became necessary to make a lot of moves at one time but also with efficiency and at a low cost. The first thing that was noticed with the institutional investor trading was that it needed more speed. The second thing was that in the early 1970s when the ERISA law was introduced, which is sort of what created 401K plans, and when what is called the modern portfolio theory started with diversified baskets of Investments, it caused a lot more trading to be done. Trading at that point needed to be done a lot faster, more efficiently and at an even lower cost. Computers came in to play at that point just like they’ve done in every phase in life.

The Evolution Over the Years

The level of computer trading was low in the 70s and 80s at around only 20-30%. In the modern age, machine lead trading is at about 80% of the market volume. Nasa uses computer algorithmic trading for calculating speed distance and spacecraft operations. It’s even gotten into our life to the point where a lot of sports teams use it for statistics and measuring players and how they perform in different situations. It’s everywhere in life and financial markets are no different. We have been asked how computer trading can be controlled, especially on a bad market day. We’ve learned that there’s been an issue or two with it in the last six or seven years, however, the Securities and Exchange Commission has gone back in and improved ways to command and control it. In 2012 the SEC did a lot of improvements and basically added “speed bumps” and “circuit breakers”. We now have good command and control on computer trading that we didn’t use to. We’ve learned and make changes along the way. With computers, you do get more efficiency and more speed but they’re only as good as how they are programmed by human beings. We’ve had a couple of incidences the last six or seven years that we’ve had to go back in and control such as the flash crash in 2010 but we wanted you to realize, yes computer trading is a part of life and it can exacerbate volatility a little bit but it is necessary with more complicated financial models that we need to put in place. What does not change is that the fundamentals of good long-term focused investments and good long-term planning are more important than ever and even though we’ve got more speed in the markets and more computers, those are the fundamental factors that are timeless and do not change.

 

Ashley Page, JD, MBA
Senior Vice President
Wealth Consultant
Email Ashley Page here

 

Fi Plan Partners is an independent investment firm in Birmingham, AL, serving clients across the nation through financial planning, wealth management and business consulting. Fi Plan Partners creates strategies in the best interest of their clients using both fee based investing and transactional investing.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

Economic forecasts set forth in this presentation may not develop as predicted.

No strategy can ensure success or protect against a loss.
Stock investing involves risk including potential loss of principal.

Securities and advisory services offered through LPL Financial, Member FINRA/SIPC and a registered investment advisor.

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