In the time it took for me to get on this stage trading robots computers traded more than a million stocks is that a good thing so we'll talk about the technology to exchange stocks or securities this is something that matters okay and to make that point
I'd like to take you back in time a couple of centuries this country Holland had produced the technology had developed the technology to build these giant ships that could sail beyond the Mediterranean to destinations the world over really it was the onset of the golden age the golden century lots of prosperity lots of growth lots of wealth created and citizens benefited but there was another important technological innovation.
People forget finance think of it would you put up the money to fund this giant ship you wouldn't even know if it would make the destination and if it did would it come back with a cargo load in one piece lots of money lots of risk so the innovation and technological innovation here was to let people buy a share literally a share of that expedition right you buy a share your neighbor buys a share somebody else buys a share you share the risk that enabled these companies in this particular case this shipping company to fund itself and create those ships you participated through your share now not only could you buy this year you could also sell it back and then you get the cash back and there was always somebody at what is called the stock exchange share exchange and this was another innovation.
Traqding Software in Netherlands
But some accounts Holland Amsterdam had the first one this is a picture I took with me from the MCM museum that shows that exchange 17th century somewhere in the middle is a hook mum a specialist would be there for you to buy a share he would quote you the ask price but you can buy that here the s price you change your mind.
You come back with that piece of paper you could sell it back to him and you get the bit price of course there's a difference between the two because the hook one needed to make a living but ideally for us trading we would like to have that distance be zero right that we can transact these securities at zero cost that bid-ask spread is a standard measure of the quality of securities markets this floor market operated that way for centuries it was only maybe a decade ago that the New York Stock Exchange operated a floor market with some human a specialist being ready.
There for you to trade today however there's been a revolution market securities market stock exchanges have changed dramatically due to technology if I show you the picture of a modern Stock Exchange it looks like this in the middle you have the exchange server matching buy and sell orders but this time they weren't walked up to this exchange server they were sending through electronic messages around it other traders the trading robots employed by investors by pension funds your pension fund is participating in this believe it or not well likely participates in it insurance companies so all of these computers send their buy or sell orders into that middle computer the exchange server and it's matched and securities are sheer strain hands change hands
This system operates at the azulene speeds beyond or below I should say microseconds a microsecond is a millionth of a second so securities are changing hands at speeds that we can't even follow because as humans we clock at roughly 1/10 of a second if you start within a tenth of a second of the gun at the Olympics you're disqualified because your brain could not possibly have registered the sound of the gun in that time frame a tenth of a second these computers would have traded securities back and forth at least a hundred thousand times and this is I guess what creates unease right we've created a monster you created a monstrous this ownership of public companies transfers at speeds that no humanor babys can follow is this a good thing I'd like to share some observations with you first is and I like to emphasize because it's forgotten in the debate about electronic trading is there's a huge benefit here in any industry.
If you replace humans by robots it's cheaper think about car manufacturing phone manufacturing really any industry so why not this industry right and to make that point I'd like to show you how the bid-ask spread remember difference between the asking a bit code how that developed through time so here is the most active US stocks trading in a 20th century yeah brought the entire century with me it's roughly you know relatively speaking.
The distance between the ask and the bit code is half a percentage point maybe a full percent somewhere in that range until in the 90s it starts coming down right all the way to your right you see that it's clearly tailing off and that's the time where the US exchanges stock exchanges started to become electronic if I bring this into the current century the graph looks like this and essentially the you know the bid-ask spreads keep coming down important stock market securities.
Markets Exchanging Segurities
markets exchanging securities become a lot cheaper but there's concerns first concern people have is maybe there's too much volatility well volatility what's that that's a difficult term in finance volatility is essentially the degree to which prices move if the company that you own a share of just produced earnings just released earnings reports that are way below your expectations maybe.
The product didn't sell as well you don't want to pay as much for the company as you used to right so the stock price so the share price should fall and that's so good because share prices should reflect the value of a company that helps allocating capital but if the stock prices move without a reason without any fundamental information being revealed that cannot be good that's creating risk without any return to make that point I thought about this a little bit to make the point.
I designed this what I call a slide all right so so here in in September 19th 2002 United Airlines filed for bankruptcy they handed in the paperwork to the US government they were bankrupt and that happens companies can go bankrupt fine a couple of years later September 6 2008 be precise somebody scanned that document put it on a webpage Google News picks it up Bloomberg picks it up Bloomberg think about that as a Google News for finance professionals and then the company stock tags within a minute it fell from $12 to below $4 two-thirds of that company's value had disappeared two-thirds had disappeared but to come back one or two hours later look at it two hours later with trading at the same price levels $11.
Almost the same price levels so that spike here in prices was not related to fundamental news in fact the computers thought you know most certainly the computers use the textual analysis to quickly read that you know scanned document essentially and they figured out this Airlines bankrupt but it wasn't because humans probably realized that.
Hey this is old news they read the date and traded it back to its value and that's the type of volatility we don't like that's risk that's we don't like that another concern another important concern about these electronic markets is that maybe there is a wasteful from a societal perspective there's a wasteful arms race going on these trading robots just to want to be quicker than the others and here is an example this is a looks like a beautiful picture no could be a Dutch landscape there's a farm there a couple of trees and grasslands in a beautiful big sky well it's close it's not all in this Belgium.
How to them to be precise but of course the salient part of it this picture is the tower that's right in the middle the tower is almost as high as the Eiffel Tower it was built by the US Army in the 70s it was sold to the Belgian government early 2000s and the Belgian government put it up for sale at the end of 2012 they hope to get 400,000 euros for it the auction start started started at 250,000 euros quickly reached 400,000 euros and at the end of the day they got five million for this tower some high-frequency trading firm bought it and his high-frequency trading firms they employ these trading robots in the market.
Why would they buy this while they bought it because it's right in the middle if you look at the map it's right in the middle between London and Frankfurt and these are two financial centers and what they wanted to do with this tower is get information what's happening. They works with nearshoring trading software developers
In one market to trade on it quickly in the other market quickly meaning just a bit quicker than the others and if you send that information through the air with microwave dishes if you can if you look carefully you can see those dishes they put those dishes on top of the tower you can see them at the top of this tower if you sent light through the air with these microwave dishes.
It's faster then if you sent the same light through the ground and glass fiber cables just a tiny little bit but that doesn't matter you just need to be faster than the others so how can you make money let me make let me just give you an example if the if the German stocks you know at this instant of time drop in value you are the first to learn with this technology in London.
European trading systems**
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Since the German and the UK economies are you know tightly integrated it's it's a good bet that the UK will fall an instant later because the quality of these economies move together now if you're the first to know you would trade you would sell in London before prices fall and then wait for prices to fall and buy it back an instant later and we're talking about milliseconds here and if you sell high and you.
I'll oh you make money and with that money that's coming out of somebody's pocket in the trading process you fund this type of investment this wasn't only this tower and the refurbishing many other expenses are being incurred by these trading robot firms that one can ask is this is this useful for society maybe the help price is moved by their trading but prices would have moved any anyways all right putting it all together I believe that the way the securities markets work today.
With these trading robots and everything electronic is a better place a much better place than the old days when there was human intermediated floor markets if you bring in the evidence that we have now then the cost savings that I told you about remember the lower bid-ask spread those cost savings far outweigh the potential concerns people have and these cheaper securities markets they help good companies to grow and fund themselves to grow and thereby add to the strength of an economy benefiting all its citizens these companies these good companies can build their ships to seal us to beautiful and faraway destinations you