The Death Of The Trading Floor

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The Death Of The Trading Floor

For many people, the words “stock exchange” conjure up pictures of guys in strange coats feverishly gesticulating and shouting to one other while hurriedly scribbling on their pads. Although exaggerated and oversimplified, this is how many exchanges (whether stock, options, or futures) used to work. However, as exchanges grow virtual and traders do business via impersonal computer terminals and phones, the human floor dealer is becoming a relic of the past.

Is there much of a future for human floor traders or human connection with practically all of the momentum on the side of electronic trading – there has been no substantial conversion from an electronic system back to the traditional approach -?

Previously the only game in town, Open Outcry Given that stock and commodity trading predates the introduction of the telegraph, telephone, and computer by hundreds of years, it is clear that face-to-face human trade was the norm for a long time. Some interactions originated as casual meetings of local merchants with similar interests (a grain buyer and a grain seller, for instance).However, the functions became more regular and specialized over time, and the persons engaged developed common norms and standards. This eventually resulted in the establishment of open outcry markets for financial assets such as stocks, bonds, options, and futures. The rules and processes differed from exchange to exchange, but they always included a trading floor (also known as a “pit”) where members transacted business. (For further information, see The Birth Of Stock Exchanges.)

Trading used to be a rather calm and orderly event, with dealers sitting at workstations and walking over to other traders to transact business, but as business increased, so did the interaction. The workstations eventually vanished, and peaceful and methodical dealing was replaced by frenetic screaming and waving, with specific hand gestures for buying, selling, and the figures involved.

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The Machines’ Ascension While a crowded trading floor may seem to the uninformed to be chaos, it functioned quite smoothly for the most part. However, member businesses and customers eventually realized what technology might offer them, especially in terms of speedier execution and reduced mistake rates.

Instinet, the first significant electronic alternative, debuted in 1967. Clients (institutions only) might use Instinet to avoid trading floors and conduct discreet transactions. Instinet was a gradual growth, not truly taking off until the 1980s, but it has since grown to be a big player alongside Bloomberg and Archipelago (acquired by the NYSE in 2006).

Nasdaq was founded in 1971, but it was not initially an electronic trading system; it was primarily an automated quote system that enabled broker-dealers to check what prices other businesses were offering (and trades were then handled over the phone).Nasdaq eventually introduced additional services, such as automated trading systems. Following the 1987 meltdown, when some market makers refused to pick up the phone, the Small Order Execution System, which allowed computerized order input, was introduced. (For further information, see Understanding Stock Exchanges.)

Other systems quickly followed. CME’s Globex started in 1992, Eurex in 1998, and many other exchanges implemented their own electronic systems.

Given the advantages of electronic systems and the customers’ desire for them, a significant portion of the world’s exchanges have shifted to this manner. The London Stock Exchange was one of the first major exchanges to convert, doing so in 1986. The Borsa Italiana converted to all-electronic trading in 1994, the Toronto Stock Exchange in 1997, and the Tokyo Stock Exchange in 1999. Many major futures and options markets have also made the transition. (For further information, see The Global Electronic Stock Market.)

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At this moment, the US is almost alone in retaining open outcry markets. Open outcry is used by major commodities and option exchanges such as NYMEX, Chicago Merc, Chicago Board of Trade, and the Chicago Board Options Exchange, as well as the New York Stock Exchange. In all of these circumstances, however, clients have electronic options, and the majority of volume, though not necessarily the majority of dollar volume, is handled in this manner. The London Metal Exchange is the biggest exchange outside of the United States that still uses open outcry.

Which is superior? Electronic trading may seem to be more straightforward or evident than open outcry. With regular transactions, computers are certainly quicker, cheaper, more efficient, and less mistake-prone – yet the error rate in open outcry trading is remarkably low. Furthermore, computers are, at least theoretically, better than humans at producing data trails that can be followed when there is suspicion of unlawful conduct.

However, computerized trading is not without flaws, and open outcry has certain distinct advantages. Because of the human factor, traders who can “read” people may have an edge when it comes to picking up nonverbal clues about counter-parties’ motivations and intents. Similar to the realm of poker, some players live on reading the players as much as playing the odds – and automated trading eliminates such signals from the equation.

Surprisingly, personal contact is frequently preferable for complicated deals. Many of the deals executed on the CBOE and other open outcry exchanges are complicated or abnormally big. Skilled floor brokers may often get better execution (better price) by “working the order” with other traders, something computerized systems cannot accomplish as effectively. (Learn about several low-risk strategies to invest in overseas markets.) More information may be found at Playing It Safe in Foreign Stock Markets.)

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The Floor of the Future Despite the potential benefits that human floor trading may provide for certain customers, the march of computerized trading seems unstoppable. Today, a considerable proportion of stock deals are handled in this manner, and no one appears to want to go back to the old practices. However, as long as members believe floor traders offer a valuable service and merchants earn enough to keep coming, there may not be much of a drive to get rid of them. To put it another way, they aren’t bothering anybody with their presence today, so why chase them out if they choose to stay?

Nonetheless, the human trade floor is all but extinct. Electronic trading dominates the financial sector as a whole, and since the impact of huge institutions on trading patterns seems to be increasing, the efficiency and speed of computer networks has cemented their place as an integral element of the trading infrastructure. (For further information, see the Toronto Stock Exchange’s History.)

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