Analog to Digital

There is a great interview with Thomas Peterffy on NPR’s Planet Money podcast this week. Mr. Petterffy is credited with bringing computers to Wall Street. In the clip below, he talks about how he cut the cord to his NASDAQ terminal and patched it into the back of a computer so that his trading algorithm could automatically buy & sell shares based on the the numbers it was reading off the feed. NASDAQ noticed the volume of trades coming over the wire from his company, and when they realized that all these trades were being executed by one computer, they pointed to a line in the user agreement that said that all trades needed to be entered, “using the keyboard.”

Peterffy and his engineers then devised a “rubber hand” attached to the computer that got around this absurd rule. The robot entered all trades via the keyboard in order to comply with the rulebook but, as Petterffy notes, on busy trading days the clacking of the robot hand on the keyboard got so loud that people in the office had to wear earplugs.

This story brought back memories of a similar, absurd set of rules that I witnessed at the Osaka stock exchange. The Nikkei future contracts were traded on the Osaka stock exchange and they had a strict set of rules that said that you could only trade these futures if you had a seat on the exchange and had staff in an office within a certain distance of the exchange. This was enforced by a rule similar to the NASDAQ rule that prohibited digital quote feeds from the floor. The only feed you could get was a video feed showing the prices and this feed could only go a certain distance from the Osaka Stock Exchange (OSE). This was, no doubt, a way to force high net worth financial firms to keep an office in Osaka. The problem was, the Morgan Stanleys of the world had a hard time convincing anyone to live in Osaka to work the Futures floor.

I worked for a US Securities firm based in Tokyo at the time and we got around the OSE rule in a clever way, not too unlike Peterffy’s robot hand. We rented a small office across the street from the OSE and installed one of their proprietary video terminals that they give to those with a seat on the exchange. In this office (which was essentially a closet), we put a camera trained on that terminal screen. We then had a computer parse that images from the camera and used software to read the numbers and turn them into digital bits which we then sent to our Tokyo traders via a leased line connection. With this home grown digital ticker feed of the futures contract numbers, our traders could run their trading desk remotely from Tokyo.

The only issue was earthquakes. Whenever there was a strong temblor, someone from the IT department (where I worked) would have to get on a bullet train to Osaka (about 3 hours away) and go to that small office to adjust the camera and re-calibrate the software that parsed the video signal and turned numbers into a digital feed.

The digitization of analog content transforms every business it touches. When you turn a musical performance into an .mp3, a movie into an .avi , or a newspaper into an .html file, it can be duplicated and transported at no cost. We think digitization is a recent phenomena but the interview with Thomas Peterffy reminds us that this transformation hit the financial services first. Shortly after the Peterffy robot, NASDAQ lifted its rule restricting computerized trading and today, more than 50% of all trades are entered automatically via computers running trading algorithms.

The robots are taking over. As we look at events such as the Flash Crash of 2010 and the Knightmare of 2012, we should be taking notes to see how the pursuit of efficiency may impact other industries that are turning to automation.

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