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I consider the open outcry pits of the futures markets to be the most open,
fair and transparent markets in the world. I consider them this even more so
than the electronic futures markets, or ECN markets where you can see the
bid, offer and size of the market. Why would this be? This is because all
the trade is done out in the open. Open Outcry. Why don’t we have Open
Electronic Trading? I think maybe we should.
Why should some of the most important dynamics of Open Outcry trading be lost
with the move to electronic trading? And is that a good thing? I don’t
think so. In terms of self-policing the markets, I think openness and
transparency are imperative towards maintaining the integrity of the markets.
I can't see the "Round Trip" trades in the energy markets occurring, or
taking so long to be discovered, if they were done in a more open and
transparent market structure.
The more information about a market that is available, the more trading there
will be. I am not the only one to ever offer this opinion, but I concur with
it. The more trading you have, the better the price discovery and risk
management. The better the price discovery and risk management facilitated
by the markets, the better off we all are. And that is what the markets are
about, the public and common good.
The markets are not about making money for those people and institutions that
can job the market structure to their favor. Sometimes though, it seems like
that is true.
When traders are forced to participate in the light of day they will uphold
higher levels of commercial honor. When they can transact business behind
closed doors, or away from the competition of the open market, then lower
levels of commercial honor seem to be applied. It is an unfortunate truth
and we see many examples of this within many of the market integrity harming
headlines of the last year.
I will not say that one format (Open Outcry or Electronic Trading) is good
and one is bad. Instead, I will say it is a matter of adequate, good, better
and best. And to me it is not a matter of what the venue is, pit trading or
electronic matching engine; it is matter of the dynamics of the marketplace.
I give high marks to openness, transparency and fairness. The pit is more
open than an electronic matching engine because of the face-to-face trading.
However, a matching engine is more open because larger amounts of volume and
number of traders can be accommodated at one time. Both are important. Why
must we sacrifice one to get the other? The pit has many more functions than
just creating the bids, offers and trades. And many of those functions are
directly related to the openness of the process.
The open outcry pit is transparent. Every pit trader has the opportunity to
see the pit trades occurring and who is doing what. When we move to
electronic matching of trading we lose the transparency of who. Electronic
trading offers greater transparency to what is in the book of bids and
offers, but electronic trading also suffers from an inability to see the
number of traders in the pit ready to make markets. And we lose the ability
to judge the quality of the buying or selling. We get more what, but lose
the who.
Pit trading gives an advantage to the trader standing in the pit. There is
stimulus that the pit trader receives that only they really get. Electronic
trading, whether first in first out, or with a size algorithm, allows for
greater outside participation. The ability of the outside trader to buy the
bid, or sell on the offer, in a greater frequency means the market is fairer.
The pit can facilitate this occurring, but even many CBOT bond locals try to
exit trades they received the edge on in the pit by putting the exit into the
first in first out a/c/e electronic matching engine.
There are many who support the concept of open, fair and transparent markets,
especially when it only applies to the other guy. As long as I don’t have to
show my hand, I support the concept. Or so the thinking goes.
I think I would be hard pressed to find support for more open electronic
markets among some of the larger institutional players. But then I know it
is very hard for some local traders to give up the advantages they enjoy in
the pit. It is hard for everyone to give up the benefits or edge they enjoy.
It is against their nature. We want the advantage and our opponents at a
disadvantage.
It is these seemingly intractable attitudes in the face of the unstoppable
change of the electronic trading revolution that will leave us with inferior
markets structures in the future. The pit trader/futures exchange
member/industry leader who does not support making electronic trading as
open, fair, transparent and robust as possible today exposes all us futures
traders to the potential of less open, fair, transparent and robust markets
in the future. I can’t stress this point enough.
The technology of today allows for a much greater level of Open Outcry-like
openness and transparency for electronic trading than what was possible when
these systems were designed 10 years ago, or even 5 years ago. Some of those
dynamics were left behind because the technology would not facilitate them.
If those market participants who value the openness of the open outcry pit
don’t vigorously support designing that openness into the today’s matching
engines, that openness will be lost. The same dynamics of entrenchment which
the current open outcry markets lean so heavily on today will apply to the
less open, less transparent and less fair market structures of tomorrow.
Every good trader knows the best trade is the one that is the hardest to do.
For Open Outcry stalwarts that means supporting matching engines which
replicate as much as possible the openness, transparency and fairness of the
Open Outcry markets. It means making the electronic trading venue as
competitive as possible with the Open Outcry markets. While some of these
pit traders will plead ignorance of matters involving technology, it is not
their knowledge of technology upon which they must draw. It is their
knowledge, understanding and reverence for the Open Outcry markets and
process that they participate in every day upon which they must draw.
The concept that some market participants, because of their size or their
sophistication, are legally allowed to participate in markets with less open,
transparent and fair dynamics is wrong. Markets are inter-related. One
market affects the next. We can’t allow a market structure that puts the
rest of the inter-related markets in harms way. There must be standards for
trade reporting, transparency, openness and fairness that apply to all
markets. I am not going to list what I think those standards are. That is a
matter for a future debate between people a lot smarter than I.
Lets not lose the openness of Open Outcry. A more open Electronic Trading is
possible and preferable. It is just my humble opinion, but it is something
to think about.
Regards,
John J. Lothian
Disclosure: Futures trading involves financial risk, lots of it!
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