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Point of View

The reality of today’s trading floor

By Mark Ward, Head of Execution Trading 

 

Movies such as Wall Street, Trading Places, The Wolf of Wall Street and Rogue Trader depict a rather out-dated view of the trading floor. The vision of brokers yelling into a phone held to each ear, or floor-traders passing instructions to runners who scuttle over to the pit-traders who are shouting and trading via hand signals, is now largely a thing of the past.
 
Few films focus on the modern, electronic, scientific, screen-based way that most securities are now traded (presumably because it makes less interesting viewing), hence few outside of the industry are aware of how advanced modern systems have become.  

The origins of the trading floor and open-outcry

The first “modern” bourse was the Amsterdam Stock Exchange, established in 1602 by the Dutch East India Company, and technically even earlier examples of organised Loan Stock trading occurred in 14th Century Florence.  
 
The Royal Exchange in London started life in 1571, but for the first 100 years stockbrokers were not allowed into the building as they were deemed too uncouth. Instead, they had to operate out of local coffee houses. Bubbles were rampant, and fraud was commonplace, so parliament caved in to pressure and banned “unchartered” companies from forming.
 
In 1801, the first regulated stock exchange opened in London, and the New York Stock Exchange followed suit, opening in 1817. The use of hand-signals allowed for anonymous trading, and pit officials and committees could deal with price disputes instantly. The big downside of pit-trading was efficiency – a broker calling the floor, waiting for a clerk to take the order, to relay to a broker, traders negotiating price, then waiting for a fill and confirmations – would all take time. Since time is money, modernisation of this system became a matter of time, not to mention the need for closer regulation.
 
While there are still examples of floor-trading in existence (the New York Stock Exchange still executes a small amount of trades via open-outcry), most is now electronic.

Voice-broking – a halfway house between open-outcry and electronic trading

Trading didn’t move from floor to electronic immediately. Voice-broking uses screens to obtain indicative prices, but the trade is negotiated and executed over the phone, or via a messaging system.  It allows for greater price clarity as there is a screen indication of the levels participants will be willing to trade at. It also allows a trader to use these levels to try to negotiate a better price for their clients. Phones are recorded, so disputes can be resolved relatively easily, and it means if there is wild market turbulence, there is still a human involved to ensure erratic trading is managed in an orderly fashion. It allows participants to trade large size without moving the market, and access liquidity that would otherwise be unavailable.

The downside with voice-broking is that that pricing is often not available to the whole of the market, so it’s not as transparent as electronic trading. Indicative prices can also vanish once someone tries to trade at the advertised levels. Trade analysis and benchmarking is more difficult, and it is very much a relationship-based arena.

Electronic trading – the way of the future

Electronic trading removes voice interaction, and trading occurs via the click of a mouse. Participants enter their prices and volume, and the trader on the other side of the deal will buy or sell the security, all without knowing who is behind the order. It means, in theory at least, that all market participants have access to the security and can trade seamlessly. It allows price transparency, efficiency and complex trade analysis. There is no need for dispute resolution or listening to phone calls to resolve queries. Trading costs have dropped, and investors and can now access the world markets from anywhere, receiving pricing and news in real-time.
 
Liquidity has also increased thanks to day-traders and the retail market entering the fold, and new products such as Exchange Traded Products. Smart Order Routers allow traders to enter an order, and the program will seek out the best price from multiple exchanges and venues. Algorithms allow for orders to be worked specifically, for example to trade more during times of the day when there is more historical liquidity, which was near-impossible to do in the past.
 
Of course, there are always drawbacks. In 2010 the Dow Jones suffered a flash-crash that wiped 1000 points from the index, caused by electronic trading and algorithmic participants. Knight Trading in 2012 lost $440,000,000 in just 30 minutes from a computer glitch in their system that started placing erroneous trades. It also causes a loss of relationships with the wider market, as it is all anonymous and relies less on human “gut feel” for the markets since algorithms and trading models are generally very binary in nature.
 
But the advent of MiFID II, arriving in 2018, will see even more products in Europe move towards electronic trading, particularly a large portion of the fixed income market, which is traditionally voice-broker driven. It also moves to limit the amount of trading on Dark Pools, so the whole market has even greater transparency.

How do we work at Sanlam?

The trading desk here at Sanlam has dealers with pit-trading, voice-broking and electronic experience, so we combine these skill-sets to provide clients with a tailored experience. Most orders are traded on the electronic markets, as it is often the fastest and most efficient way. But as the desk trades bonds, as well as large size equity orders, Sanlam also utilises Inter-Dealer Brokers, market makers, and banks to facilitate trades. We also voice-broke illiquid securities, so clients will always have access to the best liquidity pool.
 
When clients wish us to deal algorithmically, we have traders that are also experienced with non-electronic markets, who are used to watching indicators that a computer cannot pick up, and can intervene in the algorithms if required.

The future?

Ultimately, it’s likely that everything will move to electronic trading, despite protests from the voice-broking industry and the few remaining open-outcry exchanges. This will no doubt be as much a sad day for the brokers as for the Hollywood film industry.

Investing involves risk and the value of investments and the income from them may fall as well as rise and are not guaranteed. Investors may not get back the original amount invested.