Futures Trading’s Shift from Open Outcry to Digital

Picture going from using a manual typewriter to making the switch to a modern computer. They’re significantly different, right? This distinct shift is comparable to the transition from open outcry pits to current digital platforms within futures trading. Although both present their advantages and drawbacks, this evolution has not only altered the way that trades are executed, but also the structure and dynamics of the futures market at large.

The Buzz of Open Outcry

Historically, futures trading has been centered around the trading pits of exchanges such as the Chicago Mercantile Exchange (CME) and the Chicago Board of Trade (CBOT). Trading pits are a communal space where traders, brokers, and other market makers gather to buy and sell futures contracts by using a system known as open outcry. 

Open outcry relies on the physicality of market participants—from hand signals, to vocal calls, and simple physical presence to communicate bids and offers on the floor. In their height, trading pits were lively and booming, with prices being determined by real-time supply and demand dynamics made visible by traders.

The Advantages and Challenges of Open Outcry

The golden years of open outcry may be behind us, yet the system is still used within the industry today. It is important to note that there are some advantages that it holds over advanced tech and also some drawbacks that make it less viable for some market participants.

Strengths of Open Outcry

1. Transparency: Every individual on the floor can see the prices and quantities that are being traded. This helps to ensure that executed trades are fair and less likely to be impacted by market manipulation.
   
2. Market Depth: Open outcry provides a direct and real-time snapshot of supply and demand. These market insights can help traders to enhance their decision-making, achieve more accurate pricing, and improve their strategy. An additional advantage that traders in open outcry had was their ability to “sense” the way sellers or buyers are leaning before their trades are even signaled in the pit. A seasoned trader or broker can use that to get better pricing for his or her customer.
   
3. Lowered Risk of Tech Glitches: Open outcry has a much lower reliance on electronic systems compared to digital trading. While you could argue some negatives to this, a valuable insight to consider is that the risk of technical glitches or system failures is greatly reduced. Technical issues embedded in the nature of the electronic framework we use to execute trades over a large variety of hardware, software and internet pathways from across the globe.

Drawbacks of Open Outcry

1. Limited Accessibility: Open outcry restricts participation to individuals that are physically on the trading floor. On the other hand, digital trading offers global accessibility, allowing for traders to access the market from almost anywhere with just the click of a button.
   
2. Increased Risks: The hectic and noisy environment of open outcry trading, alongside manual processes, heightens the risk of errors. Miscommunication and manual errors are more common due to the chaotic nature of trading pits. These are called “out-trades” and can cost a trader a lot if the counterparty was a broker.
   
3. Limited Information: With information being verified by word-of-mouth, the open outcry system can lead to fundamental misunderstandings. The system also handles a limited amount of data compared to digital trading platforms, which offer much more comprehensive market information.

The Shift to Electronic Trading

The late 20th century marked a new era within futures trading and the world. The evolution of technology rapidly began to climb, providing new advanced systems for traders to explore. Traders needed more efficient solutions and they were beginning to see that the boom of new tech may be the answer. In 1992, CME Group introduced their Globex System. Traders began to trickle towards adopting digital platforms; many of whom would leverage electronic trading while standing in the open outcry pit.

Electronic trading platforms allow traders to enter orders directly into a computerized system and get matched with other orders in real-time—all from the comfort of their desk. This new system removed the need for physical presence on the trading floor, opening up the space to a much wider range of market participants. 

The Advantages and Challenges of Electronic Trading

The rise of electronic futures trading has catapulted the industry forward, bringing new levels of speed and efficiency to the forefront. Although the tech offerings we have gained over the past decade have aided traders in extremely valuable ways, there are still some drawbacks that should be noted about electronic trading.

Strengths of Electronic Trading

1. Speed: Trades can be executed in milliseconds. This allows for traders to have more opportunities to capitalize on current market movements quickly.
   
2. Global Access: Electronic trading platforms equip traders from almost anywhere in the world with the ability to participate in futures markets without being physically present. This increase in accessibility opens up market opportunities to a much wider scope of market participants.
   
3. Advanced Analytics and Tools: Market participants are empowered by new tools, analytics and strategies. With this new technology, they have access to a wide variety of tools that they can leverage to refine their trading approach.

Weaknesses of Electronic Trading

1. Security Risks: When placing and storing secure information within online systems, there is always a risk of security. Cyber attacks can compromise trading systems and cause breaches of your confidential information.
   
2. Market Impact: When a market participant executes a large trade, this can cause significant price movements that lead to adverse effects on market conditions. If you execute a large trade, you may deplete the available liquidity within the market. This can make it more difficult to execute any future trades at favorable prices. The reduction in liquidity can present wider bid-ask spreads and increased slippage, both of which impact the efficiency of the market.
   
3. Over-Reliance on Algorithms: Automated systems can bring traders profitable results but they are by no means perfect. Some algorithms may perform excellent under certain market conditions and poorly under others. Traders that rely too heavily on algorithms can also be missing an important factor: human judgment. When the markets shift quickly, algorithms can lack the nuance and understanding that human insight provides.

The Impact on Market Structure and Participants

The transition from open outcry pits to digital trading has changed both the structure and roles of market participants within the futures markets. The rise of electronic trading has also led to the consolidation of exchanges. This is due in part to larger exchanges acquiring or merging with smaller exchanges to stay competitive. 

Market participants have also had to adapt to the new digital environment. Traders have begun to turn to algorithmic trading strategies to better navigate electronic markets. Many market participants have also begun to utilize the breadth of tools and systems to assist them within the planning and execution of their trades. 

At EdgeClear, we pride ourselves on providing traders with state-of-the-art technology. Our suite of advanced trading solutions includes the following:

• EdgeProX — EdgeProX is our platform that is made for traders by traders. The platform provides traders with unique customization—from customized chart intervals, market alerts, total DOM control, and a personalized workspace. It also offers a robust suite of testing tools to help traders to refine their edge, all at $34.99/month.
  
• EdgeWatch — EdgeWatch allows traders to take a deep dive into their trading performance. This free plug-in helps you to measure your performance, better spot trends, categorize trades, and make more well-informed decisions.
  
• EdgeQX — EdgeQX is our automated trading solution that is powered by advanced algorithms. This program analyzes market data and makes data-driven decisions on an intraday basis for both the E-mini and Micro E-mini S&P 500 markets. 

Looking to the Future

Looking ahead, the future of futures trading is likely to be shaped by ongoing technological advancements, regulatory developments, and changes in market dynamics. Artificial intelligence (AI) and machine learning are expected to play a growing role in trading, with AI-driven algorithms having the potential to surpass human traders in their ability to process information and execute trades.

Conclusion

The transition from the trading pits to electronic trading represents one of the most significant changes in the history of futures markets. While the open outcry system was defined by its human elements and physicality, electronic trading has brought speed, efficiency, and transparency to the forefront. This evolution has not been without its challenges, but it has ultimately reshaped futures trading into a more accessible and dynamic market. As technology continues to evolve and new trends emerge, the next chapter of futures trading may transform the industry in ways that we cannot even fathom.

Derivatives trading involves a substantial risk of loss and is not suitable for all investors.

~ Niko Pozzi, Commodity Broker