In August, the Nasdaq exchange froze for three hours due to a faulty connection, and Europe’s largest derivatives market shut down for an hour because of a glitch.
In our era of smartphones and Wi-Fi, it is easy to forget that the Internet is bound by physical infrastructure. Massive servers housed in high-rise buildings, transoceanic fiber-optic cables, and myriad routers and switches crisscrossing the globe have transformed not just how we communicate, but almost every aspect of modern society.
Generally, this is a good thing. But our increasing reliance on the benefits of this vast network means we must also acknowledge the Internet’s limits and the potential consequences of exceeding those limits. The stock market in particular is at risk of hitting a major breakpoint.
The market was intended to be a long-term vehicle for companies to raise money and for investors to reap the rewards after their money was utilized to grow those companies.
Over the long term, markets are efficient and generally increase in value. In the short term, however, there are market inefficiencies and fluctuations, which traders speculate on for short-term gains and losses.
This type of short-term trading is tantamount to legalized gambling. While it has been around since the beginning of the stock market system, in the 21st century short-term trading has been taken over by Internet technologies and accelerated beyond recognition.
High-frequency traders use complex algorithms to exploit micro differences in trading prices over time – not in years, months or days, but in seconds and milliseconds.
Increasingly, winners at this new stock market game are determined not just by the fanciest algorithms but also by the speed of the hardware that provides access to the information needed to plug into the algorithms. The process is already fast – news of an event goes from the wire to a trader’s computer network in milliseconds. But the difference between recognizing and reacting to that data nanoseconds faster can mean billions lost or gained.
These tiny fractions of a second (much, much faster than a blink of an eye) are so important that some traders have gone to great lengths to improve their speeds. Many have purchased dedicated Internet cabling, some have gone so far as to move their computer networks to be in close physical proximity to the data centers of the stock exchange and news outlets, paying hundreds of millions of dollars for direct access.
The stock market was meant to work as a long-term system. Applying these short-range game tactics is risky, especially at the speed at which we’re now moving. A rational solution would be to limit the amount of trades any individual or group could do on a single stock. But there is very little appetite for that.
Any time a network goes through a breakpoint, there are two possible outcomes. More often than not, the network implodes and dies. But systems leveraging a network, those relying on existing network infrastructure, usually fare better.
The stock market is such a system. So long as we do not allow it to be abused, our markets will grow stronger and become more efficient. To do so, however, we must paradoxically slow down the system to allow for maximum efficiency.
(Jeff Stibel is the chairman and CEO of Dun & Bradstreet Credibility Corp. His newest book is “Breakpoint: Why the Web Will Implode, Search Will Be Obsolete, and Everything Else You Need to Know About Technology Is in Your Brain.”)
