How does manual trading work? (i.e. “in the pits”)
I can see how an electronic market system, like the one used for NASDAQ can be used, but how in the hell does anyone ever get anything done on the floor of a traditional commodities market?
I’ve seen all the stuff about what the different hand signals mean, and I know how the mechanics of the actual market work, but my question is more fundamental. Specifically:
How do I know whom I’m trading with?
How do so many transactions get completed when it’s just a bunch of people shoving slips of paper and yelling at one another?
How can I be sure that my trade get excecuted?
How can I be sure that someone’s not forging my trade or that my trade will be honored when everything’s settled?
How in the hell is anyone able to keep up with everything that’s happening?
Maybe a lot of this is being replaced with computers and electronic markets, (for instance, I know a lot of natural gas and electricity trades don’t even occur in a market, it’s just on a computer network) but in that case I guess my question is more historical and just as interesting.
I think the people on the floor are an elite group of folks. I don’t think just anybody is allowed to go down there and start trading. The people certified to do this have the full trust of the market officials and fellow traders. If there’s some monkey business going on, I’m sure the rest of the floor traders are immediately aware of it. A little checking with their collegues will quickly turn up the culprit for tar and feathering.
In a small enough group of people with a common business culture, the old handshake and scribbled note still suffices.
My question about commodities trading: when someone makes a DISASTROUS move (like contacting to sell orange juice futures at a low price, then a freeze hits Florida), how do you make him honor his contract? Presumably he has to have the cash to cover his positions-but suppose he doesn’t-is there an insurance fund of some kind to cover these mistakes?
I’m under the impression that individuals can’t buy or sell stock on any exchange on thier own - they have to go through a broker that is authorized to trade on that exchange.
If any individual can’t make good on the purchase cost, it’s the broker that ultimately makes good on it - and then the broker owns the resulting stock.
I don’t know what happens if/when an authorized brokerage firm goes belly-up.
(In the “Trading Places” movie, I believe that the brothers owned a brokerage house.)
I know stocks better than commodities, but they’re pretty much the same. (I do find your first paragraph amusing, sort of like saying “How did people get from place to place before they invented cars?”).
On the NYSE, stocks are sold by specialists. These are individuals who buy and sell stocks for a small group of companies. If you wanted to buy GE, you’d go to the specialist who handles GE stock. You’d give him your order and the amount and he’d try to match you with someone who was trying to sell the GE stock. If no one’s selling, the specialist sells the GE stock out of his own account.
You don’t actually know who you’re trading with, though another broker might be near the specialist trying to sell when you go there to buy. One completed, the specialist writes the order down (there’s a shorthand, so it only takes a couple of seconds) and it’s taken to be officially registered (this may be done electronically these days).
I assume commodities are similar. Some broker has pork bellies and wants to sell them. You go to him and offer a price. Once the sale is completed, a record is made.
“What we have here is failure to communicate.” – Strother Martin, anticipating the Internet.
OK, hold on tight. Long post coming. First, to answer some questions:
johnnyharvard
You recognize him, believe it or not. There’s not a lot of people who do this, and the ones who do tend to stick to one or two commodities. So if you are a corn trader, for example, you’ll pretty quickly get to know all the other corn traders in your market. Heck, you’ve probably gone out for beers after work with most of them. That said, traders wear jackets with a color and a name tag that identifies them and their firm.
Everybody is in a really big hurry, and the ones who are not fast don’t last very long. How did I ever get to break up so many asteroids in that video game? Practice. More on this later.
The traders are only part of the process. After they do a trade, they communicate that information to a clerk, who puts it into a computer.
Pretty much the same reason that a Congressman can be sure that no one will falsify his vote on the floor of the House. Because a person who did such a thing would do it exactly once and then get into so much trouble that Bill Clinton would have sympathy. That said, disputes do occur. The exchanges have officials to arbitrate disputes, and appeal system.
They don’t. They only keep up with what’s happening to them. Take corn. The corn pit at the CBOT is octagonal, on stairs, so all the traders can see each other. In the corn pit, each part of the octagon is dedicated to a delivery month. So if you am trading September corn, you know exactly where to go and all other traders of September corn will be there. Traders of August corn and October corn will be to your left and right. Think of it like a large train station. When you look down during rush hour, it’s hard to imagine how anybody gets anywhere with all those people running around. It works because each person is only going to one place.
Yep. Even for more traditional exchanges, traders are of diminished importance. I don’t recall the exact numbers, but most of the trades done at the New York Stock Exchange are done by computer (but most of the volume is still done by people). That said, many customers still feel like they get better execution if they have a real live person looking out for their interests, especially if they are trying to move a lot of stock. The big exchanges, eager to reinforce this feeling, have dedicated considerable public relations resources to explaining the benefits of their systems. You can learn more about this at the web sites of the Chicago Board of Trade (commodities) and the New York Stock Exchange (stocks)
egkelly
Nope. No insurance per se. But to get onto the floor, each seat-owner must place a large deposit with the exchange and provide net worth, open position and liquidity information on a daily basis. One of the exchange’s most important jobs is to minimize the possibility that one members will default on its trading obligations. And WillGolfForFood is right. The seat owner is responsible for all trades, whether they are for his own account or for a customer.
And finally one small nit. On the NYSE, most large trades are not done through the specialist. The small trades are “executed” by the specialist in the sense that they go directly to his post rather than the broker’s post, but he has minimal involvement (it’s done by computer from his order book). For large trades, most are done trader-to-trader right in front of the specialist. The trade then goes into the specialist’s computer to get printed on the tape, but he is neither a buyer nor a seller in these instances. The specialist’s job is to act as a buyer or seller of last resort. Specialists also keep the book of limit orders and will often execute those trades. The CBOT, for the record, does not have specialists.
Full Disclosure: I recently evaluated for investment purposes a large specialist firm at the New York Stock exchange. I or my affiliates may be long or short a position in one or more specialist firms. That position may change at any time. This post is not to be taken as investment advice, but rather as a general description of the functioning of financial marketplaces. Information is derived from sources believed to be reliable but is not guaranteed.
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