Online stock trading has brought the ability to participate in financial markets to nearly every person in the U.S. We tend to take for granted how quickly we can process our trades, how low the fees are, and how we rarely encounter the types of scams that dominated the stock market in decades and centuries past. What’s more, these innovative changes have occurred only quite recently. To get a better appreciation for how far we’ve come, it’s worth taking a look at the history of online stock trading.
1300s-1500s – Debt Trading
It’s hard to pinpoint exactly when trading became a part of the financial world. We do know that debts were traded as far back as the 14th century. Lenders would trade risky, high interest (and high profit) loans for a more sure bet (though lower profit) loan from another lender. Soon these lenders were also in the market for government debts in the form of bonds. From there, lenders realized they could sell these debts not just to other lenders but to average citizens. This increased competition in the market and allowed moderately wealthy people to participate in the financial world for profit.
By the late 1300s, Venice, Italy became the first informal trading center. Early “broker” type workers would carry thin slabs of slate with the day’s newest information on debts for sale, including bonds from other governments. These brokers would meet with interested investors on the street.
Entering the 1500s, not much had changed. Belgium became home to the first formal exchange, but it was not a true stock exchange. Stocks as we know them today were not a concept for another century. However, Belgium’s exchange was centralized in a way that allowed investors and lenders to meet in one place. By this time, individual debts had joined the business and government debts as potential investment opportunities.
1600s – Stock Trading
The first time we see modern stocks is during the rush to initiate trade between the East and West. The East India Trading Companies from England, Austria, Holland, France, Portugal, Sweden and Germany had to spend a lot of money on ships, supplies and staff to journey to eastward; however, the profits were tremendous if they succeeded in bringing back spices, silks and other valuable goods.
The Dutch East India Company was interested in start-up investments for its upcoming voyages, so it held the first ever IPO in March of 1602. To ease the upfront cost, it began to issue stocks in its company. The investors who held these stocks would receive a percentage of the profit if and when the ship returned home, which usually took a few years to complete. The investment was returned with profit or, if misfortune struck, the investment was lost.
To minimize this risk, investors would bet smaller sums on multiple voyages, a primitive approach to the still-important portfolio diversification. If at any time the investor started to have doubts, he could sell his share of stock just like debts were sold in previous generations.
Stocks at this time were issued as certificates printed on paper. The certificates could be traded with brokers, but these sessions quickly moved off the street and into cafes and coffee houses. A seller could ask the broker to list his stocks, which would be disseminated through bulletin boards or mailers. Brokers would usually hold the stock certificate while it was listed for sale. Buyers who saw these ads could meet the broker at his public meeting place, pay the necessary price, and the broker would hand this amount (minus his brokerage fees) to the seller.
So there you have it: a very primitive stock exchange.
1711 – The South Sea Bubble
There are have been many bubbles and crashes in stock history, but the South Sea Bubble is worthy of a quick mention. With the success of the Dutch East India IPO, the notion of selling portions of a company took Europe by storm. At the time, the idea of a ship journeying so many thousands of miles away was fantastic and—in some ways—unreal. The goods brought back were those only heard of and rarely seen by anyone but the wealthiest of royalty. So the excitement of entering a new era led many people to be easily fooled by outlandish claims from upstarts seeking IPO investments before any proof of legitimacy or profits had been shown.
The most infamous scams were those claiming they could build land mass onto the seas around England or harvest energy from vegetables. It seems ridiculous now, but there was an air of “anything is possible” combined with a “get in on it before it’s big” investment strategy. A bubble formed and soon collapsed as these illegitimate businesses folded without ever making a profit. The crash was severe and led England to ban the issuing of stocks until 1825. Despite the European failure, the concept of stock trading quickly crossed the ocean and grew strong in the U.S. over the following century.
This South Sea Bubble is not unlike the dot-com bubble that would occur in the late 1990s. The excitement of new technology combined with the ability for the common man to participate in the financial world through online stock trading led to a lot of sour investments.
1790 – Philadelphia Stock Exchange
The very first stock exchange in the U.S. was based in Philadelphia. Originally dubbed “The Board of Brokers,” it was established in a coffee house later known as the City Tavern where businessmen would meet to exchange investments. In 2008, it was bought out by NASDAQ.
1792 – NYSE established
2 years after the Philadelphia Exchange was introduced, New York business investors and brokers found themselves in similar need for a physically and logistically centralized plan for trading.
It began with just 24 stock brokers who had had enough of meeting beneath a buttonwood tree located at 68 Wall Street in New York City. A constitution was later drafted in 1817 to solidify the exchange’s practices, including the preference given to other brokers working within the exchange and a flat 0.25% commission broker’s fee to avoid unfair competition.
Thus the New York Stock Exchange was born. (Well, almost. It was the New York Stock & Exchange Board until the modern day name change in 1863.)
The NYSE is still one of the most powerful exchanges in the world and went without real competition until 1971, when the NASDAQ was introduced.
1870s-1920s – Bucket Shops
Imagine you are just a regular person who wants to invest in a large company, but you’re not a big enough player to work with the busy stockbrokers on the exchanges. Today, you have the advantage of a robust online trading system through which you can place your own trades, no matter how small. A similar solution was devised in the late nineteenth century called a “bucket shop,” but it quickly became rampant with scams.
The idea of a bucket shop was to pool together small amounts (in a figurative “bucket”) from a group of ordinary people to allow the shop owner to buy pricier stocks on the NYSE. Any profit that day would be divided up among those who contributed to the investment. From there, the shop owner would follower ticker tape updates and call in the shop’s stock purchases—or so the investors often thought.
More often than not, the bucket shop owner never purchased, sold or traded any stocks for the investors. Instead, the shops were akin to an off-track horse betting. If the ticker went up, the investors would theoretically split the profit minus commission fees for the shop owner. If the ticker indicated a loss, the investors were out their entire investment. Since the bucket shop owner never actually purchased the stocks, he kept that lost “investment” for himself. Because the owners made more money on a loss, they developed ways to game the system, including calling in a sale of real stock to force a drop in the price. Win or lose, it was the shop owner making all the money.
Bucket shops were banned following the stock market crash in 1929. It wasn’t until nearly 70 years later that the stock exchanges would ever see this much general public participation in the market with the advent of online stock trading, which cut out most of the scam-running middlemen.
1969 – ECN Technology
The age of computers brought a revolution to the stock trading industry. It took several decades to fully develop, but it began with the first digital trading system known as an ECN (electronic communication network). An ECN could display real-time data for bid and ask amounts allowing brokers to more quickly and easily match up sellers with interested buyers. The technology caught the eye of several companies that began developing software that could work with the ECN to automate trades with less work from a human broker.
1971 – NASDAQ
One of these companies to take advantage of the ECN was the National Association of Securities Dealers (NASD). Originally serving as an electronic display of the latest ticker information, they soon programmed software to create the world’s first electronic stock market. They called their product the NASDAQ, for the National Association of Securities Dealers Automated Quotations. They were also the first to begin online trading.
For its first few years, however, NASDAQ was not able to complete trades without human broker input. In fact, the process was still painfully manual, requiring 3 to 7 days to process each trade. Some trades were initiated by phone, but for the first decade of the NASDAQ most still occurred in old school floor trading.
Trading on the floor of the exchange is where we get the famous image of a lot of people in suits milling around, raising their hands and shouting out bids. Although it looks chaotic, there’s actually a method to the madness involving designated floor traders and an elaborate set of hand signals.
By the 1980s, phone trading was already beginning to overshadow the floor, and the Internet in the 90s all but brought it to obscurity. Technically, floor trading still exists today for the priciest stocks, but the sun of its relevancy has set. Even respectable publications like Market Watch have ceased to publish photos of the floor, saying the only things really traded on the floor are “camera flashes, sound bites, and high-fives.” The new century brought a new, remote way of trading stocks.
Clearly, the NASDAQ has had to adapt to survive into the 2010s, and its adaptations helped bring the technologies the financial industry needed to begin trading online. In fact, in 1987, as we’ll later see, the NASDAQ was at the forefront of another new system called SOES that again allowed small-time investors to participate in the fast-paced world on Wall Street. This was just another step toward the online trading we know today.
1982 – NAICO-NET
With the history of bucket shops and other scams, most folks were wary of working without a legitimate broker. But these brokers were not cheap. NAICO-NET, founded by the North American Holding Corp., was a part of the solution to this problem.
At the beginning, NAICO-NET was used only by business insiders, but not all brokers were thrilled with this software. NAICO-NET could connect trades so quickly that the spread—the difference between the buy and ask prices—went down significantly. The spread was where most brokers made their money, so keeping the spread thin was not really appealing to brokerage firms. The cost of running NAICO-NET was not a selling point, either. The software licensing fee was prohibitively expensive.
Where NAICO-NET succeeded was in increasing the ability for the average person to get directly involved in the markets. With the introduction of 24/7 account access, you could perform research on stock histories at any time. You could also easily participate in submitting international trades. Soon, home-based consumers were taking advantage of this platform to avoid paying high brokerage fees. A broker was no longer strictly necessary. Ultimately, the cost of the program meant only the relatively wealthy could put skin in the game this way.
Still, NAICO-NET only suggested trade connections. It could not perform them without someone at their headquarters completing the official trade.
1983 – Instinet
Remember, the trading process for many years was incredibly slow. Brokers had to match up buyers with sellers and the ensuing paperwork could take up to a week to work through the system.
This would change when Instinet, a company founded in 1967, changed up its marketing strategy. For years, Instinet had the technology to complete entirely electronic transactions. In fact, it was also the oldest ECN in the country. The company sold their electronic transaction process to large national and international banks who almost exclusively used it to buy—not sell—investments. It wasn’t until a new CEO came on board in1983 that the company began pursuing brokers to take advantage of the sell-side. With both halves united, the network exploded with professional users looking to make quicker transactions.
1985 – Trade*Plus
Trade*Plus was the first consumer-oriented online trading application. The company first offered its services to brokerage houses, but as more Americans began owning PCs with Internet access the real profitable market became clear. They spun off a consumer version in 1991 called E*Trade. Although the transaction fees were very high, it was more affordable and offered direct competition to NAICO-NET.
1987 – Black Monday
The Black Monday crash in October 1987, the largest single day decline, was in many ways a blessing in disguise. Brokers became so overwhelmed with the constant requests to sell that they stopped answering their phones. This forced the introduction of SOES, the NASDAQ’s answers to new SEC regulations. The Small Order Execution System meant everyone had to oblige small trade requests that are submitted electronically. This again allowed smaller investors and home consumers to have guaranteed electronic (and online) trading.
1991 – Etrade
Founded in 1991, Etrade is still one of the most well-known online stock trading companies. They quickly became the fastest growing company in the U.S. The percentage of Americans participating in the stock market increased from 5 percent to 20 percent as online trading became more of a household staple.
1994 – TD Ameritrade
TD Ameritrade is another familiar name in today’s online market. They began and continue to build their company through acquisitions, allowing them to become one of the largest online brokerage firms.
1996 – Charles Schwab & Scottrade
Within a year of entering the online stock trading market, the conventional brokerage and banking company Charles Schwab had registered its one millionth online account and held nearly $500 billion in customer assets.
The same year brought us Scottrade, although they did not have online trading for another two years. Scottrade was part of the client focused pricing structure with fees as low as $7 per trade. This smart move began a trend of more reasonable online trading fees.
2000 – Rapid Expansion & Day Trading
The 21st century brought the height of rapid expansion, from 12 online brokerage firms in 1994 to 140 firms by 2001. The increased competition brought more user friendly platforms, faster trading, lower fees and a host of new features. Day trading, the act of committing entirely to online trading as a full-time job, became feasible in the late 1990s and continued to grow in popularity.
2015 – Today’s Online Stock Trading
For decades, the expansion of technology in stock trading was fast-paced and continuously revolutionary. For the past decade and a half, though, progress has slowed down.
You can probably tell the major names today are the same major names that started up in the 90s. We have new features, like the ability to trade from mobile phones and tablets, and the process is increasingly faster, but industry-changing moves have been far and few between.
So for now, we will just have to wait and see what future technology can do to turn the online trading industry on its head once more.