When most people think ofstock exchanges, they often think of the fast-paced, chaotic environments characterized by colourfully dressedtraderstrying to outdo each other by shouting orders.
They are bustling and noisy spaces that are filled withtraderswho wear different coloured jackets and badges that represent theirbrokerages.Pitsare also calledtradingfloors ortradingpits.
The majority of activity takes place at the beginning and end of thetradingday.Clerks take orders by phone or computer from customers in thepit, andrunnerstransmit orders between clerks and brokers.
Brokers and dealers may represent themselves. Alternatively, they may work for firms andtradefor clients or the proprietary accounts of their firms. Specialists work their own books in thepit, making a market insecuritiesand keeping a ledger of orders awaiting execution.Since all orders are displayed, everyone has a chance to participate intradingactivity.
There are very few physicaltradingfloors that actually exist today.
The NYSE and theChicago Mercantile Exchange (CME)Group are two of the major exchanges that still havepits. That's because the trend has been tomove away from the open outcry systemand toward electronictrading. Since the late 1980s and early 1990s, many of the world's large exchanges have made the transition.
The ‘Olden Days’
When a young law student called Leo Melamed arrived at 110 North Franklin, Chicago, for a job interview at what he thought was a legal firm in 1952, the chaotic scene he witnessed blew him away. Merrill Lynch, Pierce, Fenner & Beane was actually a brokerage, and the job was for a “runner” who shuttled messages around thetradingpitof the Chicago Mercantile Exchange where financial contracts were settled on everything from bonds to eggs.
The maelstrom of people in coloured jackets shouting and jostling, marking deals on enormous blackboards and recording the end-of-day results with Polaroid cameras hooked the young Melamed.
After finishing law school and quickly aborting a stint as an actual lawyer, he returned to “The Merc”, and rose to be its chair in 1969.
Ed Davies of The Portfolio Platform tells a similar story of how it changed again during his timetrading. ‘When I started University in 1997, the LIFFEfloorwas still open outcry, when I left, it wasn’t.
The shouting had moved to multiple telephones and microphone systems’.
OnFriday 24 November 2000, at 5pm, the last three of the once 26 open outcrypitswere permanently closed. ‘By the time I graduated, it was a completely different game and many of the people I was working with were reluctant to let the old days die. Stories of life in ‘ThePit’ were constant, and to those who were new to the game, it sounded a lot like a school playground where the big kids pushed around the little kids.
Skill and intelligence seemed to only make up a small part of the requirements to be a successful trader in those days. Tall people were more visible and aggressive personalities stepped on the rest.’
‘Fortunately, by the time I got there, everything had already gone ‘upstairs’, meaning it was screen-based and in an office. When I arrived at work for my first day in the city, I saw rows of desks with screens piled high andtradersbuying and selling at the click of a mouse’.
Thetradingpitswhere Melamed and many other titans of finance learned theirtrade— and immortalised in popular culture by the movieTradingPlaces — had been slowly dying out even before the pandemic.
What is ‘Open Outcry’?
This is the method of communication between professionals on astock exchangeorfutures exchange, typically on atradingfloor. It isshouting and the use ofhand signalsto transfer information primarily about buy and sell orders.
In an open outcryauction,bidsand offers must be made out in the open market, giving all participants a chance to compete for the order with the best price. New bids or offers would be made if better than previous pricing for efficientprice discovery. Exchanges also value positions marked to these public market prices on a daily basis. In contrast,over-the-countermarkets are where bids and offers are negotiated privately between principals.
Since the development of the stock exchange in the 17th century in Amsterdam, open outcry was the main method used to communicate amongtraders. This started changing in the latter half of the 20th century, first through the use of telephonetrading, and then starting in the 1980s withelectronictradingsystems.
As of 2021, a few exchanges still hadfloortradingusing open outcry. The supporters of electronictradingclaim it is faster, cheaper, more efficient for users, and less prone to manipulation bymarket makersandbroker/dealers.
However, manytradersstill advocate for the open outcry system on the basis that the physical contact allowstraderstospeculateas to a buyer/seller's motives or intentions and adjust their positions accordingly.
As of 2010, moststocksandfutures contractswere no longertradedusing open outcry due to the lower cost of the aforementioned technological advances. As of 2017, open outcry in the United States was very limited, such as in a much more stream-lined form at theChicago Board ofTradeowned by theCME Group.
Orders are matched in thepit, allowing everyone to participate and compete for the best price. Brokers and dealerstradetheir clients' orders and place proprietarytradesfor their own firms.
The majority of physicaltradingfloors have been replaced by electronictradingplatforms but there are a few that still exist, including at theNew York Stock Exchange (NYSE).
Signals
Tradersmay shout, wave their arms, and use special signals with their hands to communicate theirtradingintentions on thefloor.
Hand signals facilitate quicktradingand make it possible to be heard above the crowd. For instance, when a trader puts their palms toward their head, it indicates a buy order. If they want to indicate a sell order, they face their palms away from their head.
Some exchanges use different signals, though. For instance, a trader on thefloorof theChicago Board ofTrade(CBOT)indicates the month of January by using their fist to mimic jamming something into their head.But someone working for the CME Groupholds their throat between their thumb and index finger to denote the same month.
Although open outcry is no longer very common,tradingpitsat exchanges now look like a hybrid of the past and the present.
There are more screens, and less jumping and shouting, but they still resemble the old ways in essence.
There is still some appeal to the open outcry system but electronictradingis much cheaper to run. Cutting out themiddlemanmeans a drop in fees and commissions fortradersand subsequently investors. There is also a higher degree of productivity due to the speed with which orders can be organised and placed.
The majority of stock exchanges do now operate through electronictrading platforms, which were first introduced in the 1980s. Exchanges like the NYSE and the CME Group kept theirtradingfloorbut began cutting brokers from thefloorin 1984 after adopting an updated system that operated by phone.
The 1990s saw more automated systems rush in with the rise of internet technology. This period saw more powerful computers, highertradingvolumes, and a drop intradingcommissions. The 2000s saw the rise of algorithmictradingand faster technology.
With this boost in technology,tradersand firms are able to benefit from a higher volume oftradesduring thetradingday.
Today
Tradinghas now overwhelmingly shifted into the world of algorithms; even the New York Stock Exchange is largely a TV studio, with most of the actualtradingtaking place at its data centre in New Jersey.
Others have survived, including the NYSE’s Arca optionsfloorin San Francisco and the Box Options Exchange in Chicago. Bucking the trend, CBOE Global Markets, where the Vix volatility index istraded, is building a new and biggertradingfloorto accommodate hundreds oftradersand will move there in 2022.
Technology advances, and we must advance with it. Holding ontotradingpitsis an example of some investment firms having too much power and not wanting to let the past go because they’re too afraid to give up what they have.
If they make a fortune by ‘bullying’ thepit, then what happens when thatpitcloses?
Computerised order books for futures and stocks have completely changed the market place. Algorithm designers are able to programme computers to look for patterns and placetradeswithout emotion.
One day, there may be no need fortradersat all, perhaps it will all be done by AI’stradingour accounts for us while we carry on with our day jobs.
For those of us whose day job istrading, this is a worrying thought, although we are many many years of reaching that reality.
However, what we can now do is link retail accounts to our professionaltraderswith years of experience, and allow them to place thetradeson the exchanges for you, as we have always done for ourselves.
The Portfolio Platformis a fintech platform that has the technology to do just that. Any retail investor can set up an account at their brokerage, subscribe to thetraderson TPP, and their portfolio will autotrade itself.
If it sounds a lot like the future is already here, then that’s because it is. You can now set up the equivalent of your own hedge fund from the comfort of your own home and let thetradersdo their thing.
Tradershave one job, to make money. And now they can do that for you.
Please do get in touch if you would like to know more about opening your own portfolio onThe Portfolio Platform.
