An Ultra-Short History of the Stock Market
An Ultra-Short History of the Stock Market
(and why the time has come for you to get involved)
In the 18th century the most important exchange in the world was the New York Stock Exchange (NYSE). In order to trade you would need the services of a broker. Each time you authorized a trade a complex chain of events involving a large number of people was set into motion. In return for these services you paid a commission. Not surprisingly, it became a pretty expensive proposition. Only by trading large volumes could the commission be negotiated down to somewhat reasonable levels. This was because handling the sale of a single share required almost the same labor as handling the sale of a million shares of the same stock simultaneously. For this reason the barriers to entry were very large. You truly needed money to make money. For individual investors determined to participate in the markets, the process required paying a lot of people along the way and then settling for the leftovers.
One of the reasons so many people were involved was to maintain order, and probably the most important person in this respect was the “specialist.” His (or very rarely, her) role was as a matchmaker between people who owned a stock that they wanted to sell and people who wanted to acquire that same stock. The information that was causing these two parties to make opposite decisions at the same time could have significant impacts on the stock price, and therefore on the ability to complete a given transaction. It was the specialist’s job to process all of the orders from a detached and professional perspective. This was necessary to keep the markets from becoming chaotic, but it often became very challenging. There was money to be made, after all, and everyone wanted their trade handled immediately. Adding to the dynamic, the specialists’ motivation to act for their own benefit on all the information they were processing was huge. Since there were many ways to profit (both legal and illegal), specialists tended to become very wealthy as a result of their position.
This situation remained virtually unchanged until the advent of computers in the late 20th century. At that time a new stock exchange called the NASDAQ (National Association of Securities Dealers Automated Quotation) emerged. Its founders embraced the efficiencies that could be created by handling a lot of the formerly face-to-face steps electronically. Additionally, this electronic exchange had the added benefit of handling transactions in a completely impartial way. If an order to buy 10,000 shares of a stock existed at a given price, nobody even needed to be aware of its existence until an order to sell at a matching (or better) price appeared. Once that happened the transaction was executed immediately. The presence of willing buyers or sellers at a given price was nowhere near as likely to generate market fluctuations and profit taking as it had previously been.
As technologies improved and access to the internet increased the markets became more and more efficient. It wasn’t long before the more established markets, including the NYSE, started adopting the NASDAQ’s ways of doing business. Simultaneously brokerage houses that were specifically designed to keep the cost of each trade as low as possible began to emerge. They created electronic interfaces where a client could execute their own trade without ever involving a broker or anyone else they might have to pay a commission to. The service was instead performed in return for a small transaction fee. As these new discount brokerages competed with one another the costs of making trades continued to drop dramatically. Eventually the cost of executing transactions became so low that was a virtually immaterial consideration, even for very small investors.
As a result of all these innovations it had become possible for an individual with a small portfolio to participate on a level playing field with huge institutional investors. In fact, in the modern markets individual investors now have important advantages over their much bigger marketplace competitors due to their agility alone. It’s possible for these investors to react to information far more quickly than any large institution possibly could.
As a result of this transformation the markets are now far more efficient than ever before, and because technology has enabled the creation of additional investment vehicles such as Exchange Traded Funds (ETFs) and options, individual investors with access to the proper information now have an amazing array of alternatives at their disposal. They can combine these vehicles, in educated ways, to minimize risk and/or maximize return no matter which direction the markets are moving. Nowadays, anyone who values financial security owes it to themselves to learn how to utilize these amazing market tools for themselves.