From the September 01, 2009 issue of Futures Magazine • Subscribe!

Lessons from pit-traded markets

When futures trading took place mostly via open outcry, professional trading firms would hire ex-athletes to train as traders. Athletes were a logical choice because they generally combined a large physique with the ability to make decisions under pressure. These traits gave them an edge in the fast-moving, physical world of pit trading. If this person also could control their emotions, they would often be successful.

But the heyday of open-outcry has passed. Is this trader profile still relevant in today’s electronic world?

In the modern world of computerized trading, we instead hear about “quant” guys. A quant guy, or gal, is a quantitative analyst, usually someone with an engineering and math background. Hired for their brains and ability to write code. These persons create computer programs that conduct trading on autopilot. No athleticism, no physique and no emotion come into play.


Although the open-outcry system does remain, screen-based trading now dominates the futures industry. Does that mean the human trader will be next to disappear? Will anyone trade without a program? Will all traders in the future be techno geeks relying solely on statistics and technical analysis? Will traders who trade on feeling and instinct survive?

“The basis of trading is a human activity,” says Tony Danielak, a veteran Chicago Board of Trade (CBOT) floor trader. “There are both quantitative and qualitative influences. A break in the Dow and a rally in crude can affect soybean meal. Emotion trades exist. Not every competitive edge can be quantified.”

Let’s examine this statement in the context of some price charts. “Stocks & meal” shows both the March Dow Jones Industrial Average futures contract and the March soybean meal futures contract. These are daily bar charts showing each session’s highest and lowest price traded, represented by the lowest and highest point of each vertical bar. These charts also show the open and closing prices of each daily trading session, depicted by the small horizontal line found on each vertical bar.

In the soybean meal chart, a support level price can be obtained by looking at lowest prices traded in each session. Clearly in January, the lowest prices follow a pattern of trades being executed around the $290 to $293 level, never dipping lower. In the Dow futures chart, this same strategy can be used, with the 7800 level maintaining support.

These charts indicate that grain prices are being affected by outside influences. A quantitative program could have made a number of possible decisions based on the data. If these programs took into consideration the support levels and looked at the soybean meal chart beginning in early January and continuing to the middle of February, the support level would be discovered at $292. Let’s assume that this support level was exploited by quantitative programs and buy orders were executed. Obviously, this strategy remained effective and the techs dominated the grain trade. This trade was quantitative, not based on the quality or character, just technical analysis.

But go into the next month. Soybean meal again touches the support level. It is now early February and the Dow closes below 7800. The next few trading sessions see the soybean meal contract breaking below the $292 level and then go on to sell off by another $30.

It is at this level that instinctual traders might have adapted a strategy that takes in influences not normally considered by a quantitative program: “The Dow is tanking and meal seems to be following. I’m going to get short.” This could be considered a qualitative trade, not necessarily measurable or relating to quantity, but instinctual.

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