Innovative technology holds great promise for the financial markets, where it makes lighter work of raising capital. With new means of communications and new uses for existing technologies such as the Internet, companies can disseminate information about stock offerings more efficiently, easily, cheaply, quickly, and with greater interactivity than ever before. Several companies have already conducted offerings entirely over the Internet. Many other issuers use advanced communications to help investors receive information.
Improvements in technology are also fostering novel approaches to trading securities in the secondary markets. Technology can lower the cost of transactions and increase the liquidity of previously thinly traded stocks. It can provide greater transparency in pricing and reduce error rates. Some companies have recently set up Internet sites where interest in acquiring shares from existing shareholders may be expressed by potential investors without recourse to traditional markets. Perhaps more importantly, technology permits qualitatively different types of trading structures to emerge.
Since all these developments can improve the way capital markets work, they are good news for investors, issuers, and the economy. They also change the way these markets work, affecting the activities of customers, brokers, regulators, and even those persons intent on committing fraud. In the future, more changes will occur if technology fosters integration of the diverse U.S. marketplaces into a truly national market system--a possibility foreseen 20 years ago, in amendments to the Securities Exchange Act of 1934. Eventually, an international market system will evolve.
Stock trading status quo
Trading starts with an investor's decision to take part in a transaction--a determination based on information in the marketplace, the official filings of issuers, the advice of brokers, and so forth. Advances in communications technology have obviously facilitated this process. Eventually, paper disclosure documents will largely be supplanted by electronic versions, since they enable issuers to reach possible investors at a lower marginal cost and with interactive and better disclosure.
Technology has also smoothed the primary offering process, in which securities are offered to investors directly by an issuer or through an underwriter. The Internet, for example, allows issuers to distribute the required information directly to possible investors at less time and cost than paper delivery requires. In October 1995, the U.S. Securities and Exchange Commission (SEC) issued a release discussing the issues raised by the Internet and other technologies in this context; few difficult technical or regulatory concerns were presented.
How customer orders are executed in today's secondary markets depends on many factors, such as the type of order and the market where it is sent for execution. Despite many permutations, there are basically just market orders and limit orders. By entering a market order, the customer expresses an intent to buy (or sell) the security at the prevailing market price. A limit order is a notice of intent to buy (or sell) at a specified price for a specified time.
By and large, limit orders are executed whenever the market price reaches the limit order price. For example, if a customer places a one-day limit order to purchase stock at $49, and the stock currently trades at an asking price of $50, the order will remain unexecuted unless someone is willing to sell the stock for $49. If the order is not executed on that day, it expires.
Technological advances offer the possibility of a new type of order, which might be called a dynamic order. This would be similar to traditional contingent orders--orders that have parameters, conditions, or constraints that determine whether a transaction will occur and at what price. But they would be dynamic in that the conditions for a series of orders would have to be satisfied simultaneously. For example, an investor might enter into a system a "dynamic" order to sell 1000 shares of a stock within a certain price range, but only if at the same time another order to buy 1000 shares of a different stock occurs at a price no greater than a set price, and provided moreover that a certain market index stays within a specified range.
With available computing power, many orders like this can be entered into a system that would proceed through a series of algorithms and iterations to determine if an order can be matched with others. If it could, all the matchable orders would be executed. This type of order would allow portfolio managers and others to engage in sophisticated trading strategies, to hedge risk exposure on a portfolio-wide basis, and to take into account co-variances among stocks or other assets and ensure appropriate portfolio-wide management. Systems of this sort may soon be in operation.
Currently, an order can be executed in many different marketplaces. A customer can designate an order-execution method, either by instructing the broker how to execute the trade or by directly inputting orders in certain proprietary trading systems. In the absence of instructions from the customer--the norm for retail accounts--the executing broker may determine where and how to execute the order by using algorithms or simply checking for the best price in selected marketplaces.
In the United States and many other countries, one traditional kind of marketplace for securities has been an exchange. A traditional exchange has members, detailed trading rules, and listing requirements for stocks traded on it. Besides the primary U.S. stock exchanges (the New York Stock Exchange [NYSE] and the American Stock Exchange [AMEX], also in New York City) there are five regional stock exchanges in the United States: the Boston, Chicago, Cincinnati, Pacific, and Philadelphia exchanges. Also, there are exchanges for trading other investment instruments, such as options, as well as many exchanges elsewhere in the world.