President's Report

Understanding computer trading in a global economy

In August, shares of New Jersey-based Knight Capital Group Inc., one of the largest trading companies in the country, sank nearly 30 percent due to a glitch in its electronic-trading system that affected about 150 stocks on the New York Stock Exchange.

The problem created concerns about the role computer trading algorithms play in today’s financial markets and its affect on investor confidence.

“Computer systems don’t have emotions, they just trade based on algorithms,” Associate Professor of Information Systems Alex Yap says. “If they see that there are more sellers trying to sell a share, these computers can predict that the trend is going down and they can predict it in a split of a second, much faster than human beings can, and immediately sell off.”

But investors do have emotions. When a glitch occurs, like the one with Knight Capital, it not only brings down stock value but also creates panic among smaller traders, making the stock market more volatile.

Yap set out to better explain how these computer systems work in his recent book, Information Systems for Global Financial Markets: Emerging Developments and Effects. Three Elon University professors, John Burbridge, Wonhi Synn and Bob Pavlik, assisted Yap with the book, which was published by Premier Reference Source.

“The book doesn’t tell you how to trade better – I think no book really has the correct answer; you have to create your own strategy for trading – but it gives you more information on how information systems behave,” Yap says. “By knowing how information systems are programmed to behave, you have a better feeling about your trade.”

The relationship between information systems and finance is important to explore, particularly in today’s global economy, where markets are increasingly connected. If, for instance, the Shanghai Stock Exchange falls 500 points, the Dow Jones or London’s Footsie (FTSE) Index would fall almost immediately by a similar margin because electronic-trading systems are programmed to trigger trades across all markets.

For retail traders, this could create problems. Yap says there are two emotions involved in trading: fear and greed. People buy because they want to make money and sell because they're afraid to lose money. As information about online trading becomes more readily available, more people are choosing to trade on their own using services such as Ameritrade, E-Trade or Scottrade. However, if they don’t know the role computer algorithms play in today’s market, they can panic and make unwise choices.

“If a stock is going down very fast, you want to protect your investment and you want to sell,” he says.  But, “if you don’t know what is happening behind the scenes, how computers are trading, then your fear becomes magnified and you feel like you have to sell … only to find out that the computer’s algorithm started buying back and the stock is going up the following day.”

“More knowledge of how these information systems are managing the global financial market will allow you to understand the individual stocks you are buying,” he says.

Yap, who joined the Elon faculty in 2002, earned his bachelor’s degree from the University of the Philippines, his master's degrees from Williams College and the University of Exeter, and his doctoral degree from the Copenhagen Business School. He teaches classes on varied topics to undergraduate and graduate students in the Martha and Spencer Love School of Business, including a popular Winter Term course dealing with financial information systems and stock trading.

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