Increasing Automation in the 70s and 80s
 
 

                Electronic Limit Books Prior to the 1980's, limit orders in the New York Stock Exchange were handled manually by market makers, known as specialists. These market makers handled limit orders, which are essentially orders to buy or sell a security at a specific price, by keeping a record of all orders and transactions in a loose-leaf notebook. They would then execute orders when the market prices matched the request by going through all the listings manually. For obvious reasons this was not an efficient system and by the mid-1980's the strain of increasing market volume was beginning to show on this manual system. By the late-1980's increasing pressure resulted on the implementation of a new electronic limit order system which would have many effects on the efficiency of the NYSE.

  
         By the middle of the 1980's, many insiders of the NYSE recognized that the combination of increasing technological advancement and increasing daily volumes on the exchanges was creating a demand for a new specialist system. The markets were not ready for a completely automated system, but using information systems technology to complement and update the current system seemed like a positive and necessary solution. In 1987 engineers began converting stocks to this new system, which would keep track of a specialists limit orders and automatically execute trades when a securities price matched an order. By 1989, all of the NYSE stocks had been converted to the new electronic system and the manual limit order book was eliminated from the floor. The effects that this system had on the market were immediately obvious.

 
       The initial impact that the system was supposed to have was to allow for increased volume. Daily volumes would no longer be limited to how many limit orders a specialist was physically capable of handling. This is a result of the fact that the electronic book greatly increases the efficiency of the specialist by automating the functions of the limit order book. Another impact, which was not as obvious at first, is the effect that the system would have on price volatility.
                        Using trading volume and market movement as control variables, it is found that at trading
                        volumes higher than 100,000 shares per day and in cases where the daily price movement
                         is at least 3 ticks, excess intraday price volatility of stocks is lower after EDB [electronic
                         dealer book implementation.
This could be explained by the fact that the electronic system provides for a more controlled execution of trades, thus eliminating the volatility associated with the random nature of matching trades manually. Additionally, studies done after the implementation of the system showed that the reduction in price volatility was achieved without a reduction in liquidity, which some people were afraid might happen. As a result, these studies concluded that the quality of the EDB market is considered to be higher than that of the manual limit order book market. This was concluded from the standpoint of reduced price volatility and from the observation that the system served to "decrease the frictional losses due to market mechanism." These are described as losses to both the dealers and the investors resulting from the frictional movement of prices with the manual system in place.

 

     The electronic limit order book was an important step in increasing the capability of the NYSE to handle large volumes of trading without increased volatility and associated risk. Additionally, it was an important step in moving towards further implementation of information systems. By having such unanimous success from all standpoints, this system showed people in the securities industry that automation is a desirable goal, which can greatly increase the efficiency of the market. Many people, in fact, chose to point to this example to express their ideas that complete automation, referred to as "uncontrolled 'screen trading'," would produce highly erratic price movement, but that this is not the case when the specialist is assisted, rather than displaced by the computer. As a result, participators in the securities markets were content to allow information systems technology to complement, but not replace the current market system.

1. Munshi, James. Stock Exchange Automation. Garland Publishing. New York & London. 1994.