If you have managed to avoid the electronic trading revolution because your markets of choice are in the old line commodities, it’s time to put down the phone and pick up a mouse. Grains, energies, metals and even meats are now all trading electronically alongside open outcry pits. And there is nothing to fear, in fact you can expect better execution and less slippage.
“It’s amazing how quick the open interest, especially in the side-by-side grains, has taken off in a very short period,” says Robert Fuhrmann, an analyst for My Futures Online. “It’s like 20% of the overall volume and we didn’t see any real drop off in the bid-offers or execution. So it was a very smooth transition to the side by side for ags and metals.”
At the Chicago Mercantile Exchange (CME) more than 75% of the volume is done electronically. “The exchanges are not interested in the least in the trading floors,”
says Larry Levin, an independent S&P trader at the CME and president of Secrets of Traders. “As far as they are concerned, they would have closed the doors yesterday. In 2006, 75% of the volume was done electronically… In 2008, that number is not going down to 40%. It’s going up to 90%. The writing is on the wall and anyone who can’t see it doesn’t know where the wall is.”
As old line commodities traders gear up to begin trading online, here are some observations and suggestions from traders who have already made the change to electronic trading from open outcry.
DIFFERENT STIMULI
Trading in an open outcry pit is a completely different experience from trading in an office on a computer.
“As floor traders, we were used to processing information visibly as well as audibly,” says James Oliff, chairman of FfastFill Inc. and vice chairman of CME Holdings. “When you move to the electronic screen that sound factor isn’t there. So unless you are watching the screen, you don’t know that the market jumped X-number of points in either direction. On the floor, you would have heard that.”
Most traders respond to the rising and falling of sound to gauge activity and excitement, which guides their trading, and that audio stimulus is a crucial difference in the experience of trading electronically versus trading in a pit. He cautions that while it is easy to be a lot more focused when trading electronically, there is also a lot of idle time waiting and watching for the market to move.
Floor traders also are used to seeing what kinds of orders are coming in and watching the order fillers act and react, knowing for example that when an institutional broker brings up 2,000 contracts, it’s usually safe to assume that he has more. But, when you are trading electronically, those cues and clues are simply not there.
“The biggest hurdle is making the transition from following the market via all of the physical signals that you see in the pit to following all the electronic signals when you set up your screen,” says Curt Zukert, associate director of the Globex Learning Center. He says that most people making the transition realize very quickly that they need multiple screens, one for your trading platform and at least one other for charts and other trading data. The next challenge is establishing your keyboard, video and mouse coordination.
“It’s a faceless trade,” Levin says, and rather than relying on the sights and sounds of the pit, electronic traders need to rely on their trading discipline and technical analysis skills to compete. “An off-the-floor or electronic trader has been studying charts since he started, and a floor trader maybe hasn’t been doing it so much.”
He also suggests that traders new to the screen use longer-time frames on bar charts. “When they come off the floor and want to trade electronically, they tend to want to use very short time frames,” such as 1-, 2- and 5-minute charts. “They get themselves really chopped up trying to trade too actively.”
RESPECT THE DIFFERENCES
Because the environments are so different, it should be no surprise that the skills to succeed in electronic trading are different from the skills required to succeed in the pits.
“A lot of people are under the misconception that their trading skills will transfer to electronic trading and that really isn’t the case,” Levin says, adding that most floor traders make their money by playing off customers or order flow, but in the world of electronic trading it doesn’t work that way.
“When you come off the floor and become an electronic trader, you realize that everyone is on the same page. You have to buy the offer and sell the bid. There’s no two ways about it. A floor trader is able to do the opposite of that,” Levin says. Not having that advantage takes some getting used to. “Now there is no advantage. You don’t have any advantage over a guy trading in Europe or the guy trading in the next room.”
While that is a disadvantage to the former local, it is often an advantage to the average retail trader. Most traders report that it is easier to buy the bid or sell the offer electronically. So whereas the floor trader can no longer count on always getting the edge, the retail trader is no longer at a information disadvantage and can sometimes get the edge.
Electronic markets also don’t trade the same way as open outcry markets, and understanding the differences in the market dynamics is key. In electronic trading there is no middle man and traders are rewarded for being the first to place an order. On the trading floor, being bigger, louder, more physical or closer to the action can create an advantage. This is an edge that floor traders are so reluctant to give up.
“[Electronic trading] takes some of the edge off of the floor and makes the playing field more level,” says Fuhrmann. “But that edge is disappearing as it is. The efficiency is just so much better in the electronic markets.”
One caveat is that when trading electronically, some firms don’t allow good-until-cancelled orders. “There are some that offer proprietary execution systems that will re-enter your order for you. You need to be mindful. If you need to work good-until-cancelled orders, on many of the electronic platforms you don’t have that ability,” Fuhrmann says.
Another difference is that experienced electronic traders actually place fewer trades than floor traders. Initially this seems counter intuitive to many traders, who assume that they should be able to trade more actively on the screen. But, because electronic traders lack the edge that they held on the floor, they quickly get into trouble.
“A floor trader can be really, really successful by doing a lot of trades because he has the edge,” Levin says. “He is able to buy the bid and sell the offer. If I can buy at one and sell at two, I want to do that as many times as I could, all day. If you do that when you are trading electronically, where you have to buy the offer and sell the bid, there just won’t be as many opportunities to find good trades, because you have to give up a tick or even a couple ticks to enter and exit the market. On the floor, someone was giving those ticks up to you.”
Levin says that he has seen many former floor traders get themselves into trouble when first making the transition to screen trading, and that until you are completely comfortable, you should trade as small as possible. “A 100-lot trader in the big S&P, who trades thousands and thousands a day, probably needs to trade one and two lots until they become somewhat efficient in trading.”
However, most are not willing to do that, expecting that they will continue to have the same success they have enjoyed on the floor. “It’s an expensive learning experience for those people,” he says.
Retail traders may be used to getting valuable market information from their brokers as they place orders over the phone. If a broker helps you with stop placements and support and resistance levels when you call him to place your orders, you may have to replace that information stream. You don’t want to be in a position before you realize that you depended on this information to manage your positions. There are multiple information providers that provide technical analysis on every market.
While electronic trading lacks the sights and sounds of pit trading, having access to multiple products, multiple asset classes and multiple exchanges through a computer screen can open many opportunities to traders. “All markets are interrelated and when you trade electronically you see all of that,” Oliff says. This difference is one of the major opportunities that open up to floor traders who move to electronic trading.
For example, if the U.S. dollar starts moving, that could have an affect on stocks, gold, interest rates, or foreign currencies. As a trader, you would then want to trade the contract that has the greatest liquidity. But, if you are on the trading floor standing in the pit, you are not likely to run from one pit to the next trying to place orders.
