Watching the way that the world of stock exchanges has changed in the last quarter of a century can make you feel like you’re peering into a kaleidoscope and slowly turning the tube, watching as, with each revolution, the little pieces fall into entirely new patterns. Yesterday’s announcement of a merger between BATS Global Markets and Direct Edge Holdings is just the first piece of yet another new mosaic taking shape, one that may set the stage for an entirely new kind of competition among financial marketplaces.
When I started covering the financial markets back in the late 1980s, stock trading was something that was done on trading floors, holding pens and pencils (but never a red pen – that was inviting losses) and with the help of telephones. And the stock markets were still the 800-pound gorillas in town, in spite of the growing interest in and usage of futures and options contracts. In a lot of ways, the only thing that separated these exchanges from the nave of a 17th century Amsterdam church or an 18th century Wall Street sidewalk was the use of a dedicated space and those telephones (oh, and the garb…).
The first big round of change came – not surprisingly – as the computer became an increasingly important business tool. It became possible for exchanges like Nasdaq – an exchange that had no physical footprint – not only to establish themselves but, over time, to redefine completely what we mean when we use the phrase “stock exchange.” One after another, exchanges closed their trading floors, including the venerable London Stock Exchange, as the old system of “open outcry” gave way to computerized trading.
That shifted the balance of power in favor of the new breed of exchanges, those set up as purely electronic forums on which professional traders could do business. To acquire the capital to keep up and to expand, exchanges worldwide transformed their corporate structure. Traditionally formed as membership organizations, with seats (giving someone the right to trade on the floor) handed from one family member to his son, or sold as a kind of investment unit, the exchanges converted into for-profit businesses and raised new equity through public share offerings. Now ordinary individuals who may never have ventured onto a trading floor in their lives could get a piece of the action by buying stock in the exchanges.
The culmination of both of these trends – and of the next great flurry of consolidation – was the merger of one of the oldest and most revered of the old-model exchanges, the NYSE, with Archipelago, one of the best-known of the ECNs, or electronic communication networks, which had sprung up as rivals to the established exchanges. The competition among ECNs and between these electronic networks and the traditional exchanges had been weighing on profits across the board, a pattern that has been repeated of late.
Once, a stock exchange had been as much a symbol of a nation’s independence as its flag, its national anthem and its national airline. Over the last century, that, too, has disappeared: A number of European stock exchanges vanished into the entity now known as Euronext, which in turn formed a cross-border merger with the NYSE and regional alliances in Asian markets. Formerly intense rivals apparently evaporated overnight, as the Chicago Mercantile Exchange swallowed the Chicago Board of Trade, creating a single derivatives trading behemoth. Then came the next radical transformation, symbolized by the Intercontinental Exchange’s $8.2 billion bid to acquire the NYSE.
If your head is spinning, don’t worry. The pace of change, in large part because it has been driven by that of the change in technology, has indeed been frenetic. So frenetic, indeed, that it has become hard for securities regulators to keep track of all the players and the technological innovations that they have brought to the table. Meanwhile, the comfortable profit margins that the big exchanges once enjoyed and that began to evaporate as long ago as May 1975, when regulators banned fixed trading commissions, have become so lean that exchanges old and new now offer incentives to convince buyers and sellers to execute transactions on their systems.
It wasn’t until 1997 that stock trading topped a billion shares daily on the NYSE; today’s average daily trading stock volume in the United States is closer to six billion. Volume is now actually declining, though – down from the nearly 10 billion shares that changed hands back in 2009. Combined with the increased technological complexity – the need to serve high-frequency traders efficiently, handle massive transactions like hedge fund manager Bill Ackman’s decision to dump his stake in JC Penney in such a way as not to allow the sudden selling to send the company’s stock price plunging, and to try to avoid events like the “Flash Crash” or last week’s “Flash Freeze” – the decline in trading volumes has left trading venues like BATS and Direct Edge unable to resist the urge to merge. The combined company will be the second-largest exchange operator in the U.S., larger than Nasdaq. Odds are that more such deals will follow – and that down the road, some entrepreneur will identify a trading strategy that the platforms of his day can’t accommodate and set out to reinvent the wheel. And the kaleidoscope will turn yet again.
In other words, if you expect the fast and furious rate of change in the securities trading world to slow down as has the volume in stock trading, you’ll be disappointed. We can hope that the exchanges will use their savings to invest in more stable systems and ones that increase transparency. But the most important things to remember remain those down laid down by 17th century Spanish student of the art of stock market trading as practiced at the time in Amsterdam, Joseph de la Vega, in his iconic Confusion de confusiones.
Remember, he wrote, “guessing correctly is a form of witchcraft,” and that advising someone what to buy or sell is a mug’s game. Remember to take your chips off the table when you’re ahead, he reminded his readers: “It is best to seize what comes to hand when it comes and not expect that your good fortune and the favourable circumstances will last.” View profits that you make from trading in stocks as “goblin treasure” that one moment is “diamonds, and the next, pebbles.” Above all, bear in mind that “he who wishes to become rich from this game must have both money and patience.”
The places that people do their stock trading may have changed beyond recognition in the last three centuries, but not the wisdom underlying it all.