FREE online courses on Information Technology - Chapter 3 THE IMPACT OF
INFORMATION TECHNOLOGY - Technology Transforms the Securities Industry
The history of the stock exchanges has been constant
increases in volume. Form an information processing standpoint, of course, the
value of a transaction does not affect back-office functions. If one share or a
million shares change hands, the same processing is required. In the 1960s the
New York Stock Exchange was closing early because it could not keep up with the
paperwork for processing and clearing trades. Yet the volume then was a fraction
of today's volume.
As shown in Table above, the securities industry invested in
extensive automation of back-office functions, first for handling trades and
then to provide information for stockbrokers and traders. Data became available
on-line to account representatives, showing them their clients' position so that
they could provide better service. These systems eliminated a bottleneck of time
in processing by speeding up the flow of transactions. The New York Stock
Exchange developed systems to facilitate routing orders faster to the floor
without requiring a floor trader. Brokerage firms also streamline their
communications with floor brokers so orders get to the broker quickly.
A second-order impact of this technology is its ability to
make possible new trading strategies; for example, program trading is greatly
facilitate by rapid order execution.
Program trading involves buying or selling a basket of stocks
that mirrors a stock index like the S&P 500. At the same time, the program
trader must buy or sell the corresponding future index on the
Chicago
exchange. The trader sells the more expensive of the two and uses the proceeds
to but the less expensive. This kind of arbitrage has generated a great deal of
trading volume and controversy.
First, program trades are created through computer programs
that contain the logic of the program trader. These programs search for an
imbalance in the price of the stock index future and the underlying basket of
stocks that make up the index then notify the trader who can generate the
appropriate buy and sell orders. The orders are probably created by the computer
and sent to automated exchange systems for execution. Because the price
difference exists for only a short period of time, it is important for execution
to be as fast as possible. If an order is too large for an automated exchange
system, the trader can generate a large for an automated exchange system, the
trader can generate a large number of trading documents for floor brokers using
the computer again. Various studies of program trading do not blame it for
increased market volatility or reduced liquidity. In terms of third-order
impacts of the technology, it seems logical there is an effect on volatility and
liquidity as technology facilities large-sized holdings and trades.
When the stock market crashed in October 1987, one mutual
fund sold more than $1 billion worth of securities. Without information
technology, could that firm have managed a multibillion-dollar portfolio?
Without technology, could it have generated enough sell orders to liquidate a
billion dollars worth of securities? Other firms that day liquidated securities
worth hundreds of millions of dollars. The combined impact and demand for
liquidity sent prices downward, possibly reinforced by another tool called
portfolio insurance. It is possible that program trades and portfolio insurance
interacted early during the crash to put pressure on prices. (Later, however,
price information was running so far behind that program trading does not seem
to have been possible.)
