The decision by CME Group to close many of its open outcry futures trading pits in Chicago and New York came in response to trading volumes falling to just one percent of the company’s total futures volumes. Thus helping to put the final nails in the coffin of a 167-year-old tradition that, for many, embodies the very heart and soul of the global financial market, in favour of the unparalleled efficiency and speed offered by machines.
Though the decision itself was a long time in the making, as a consequence of more and more volume migrating to electronic trading screens that promise greater liquidity and price transparency, when the closing bell finally rang for the last time the mood in the pits was sombre to say the least. “It felt like losing a close friend”, recalled John Pietrzak, a corn broker for more than 35 years. “It certainly wasn’t a celebration.”
The frantic, frenzied style of trading that is a staple of the open-outcry futures pits saw traders hooting and hollering for attention, all the while throwing out bizarre hand signals…
Sentiments such as these are understandable considering his family’s long history on the trading floor. His grandfather first started at the Chicago Board of Trade (CBOT) as a runner when he was just 13 years old ferrying messages between clerks and taking phone orders from customers that would then be passed on to brokers to execute. His father would then join his grandfather in pits in his early 20s. However, his own path to the trading floor, unlike his elders, was not as immediate. Instead, opting to start his financial career as a Certified Public Accountant (CPA), though it wasn’t long before he realised that it wasn’t the right fit for him.
“There really isn’t a lot of thrill in being an accountant”, he said. “So I decided to go down to the trading floor and scream and yell and try and make a lot of money.”
Another veteran of the exchange is Scott Shellady, best known for wearing a black and white cow print jacket to help him stand out from the crowd. While he, along with many of his colleagues had recognised a long time ago that the closing of the pits was inescapable, it didn’t stop him feeling a sense of loss when the inevitable finally came to fruition.
“It was sad”, explained Shellady. “There were a lot of gold guys who came back and toured the floor before they said goodbye. It is a strictly no smoking building, but I saw one guy sit down and have a big fat cigar, which was kind of a cool thing to see. It was a real passing of the torch.”
As a member of the board of directors at the Chicago Mercantile Exchange (CME), Pietrzak knew that if the futures pits continued to transact less than one percent of total CME volume, as they had done for several years, that it would be one of the first places the exchange would look to make changes. Even so, the fact that it took as long as it did to shut down the pits, shows just how difficult a decision it was and what the tradition meant to all those involved.
Hand-to-hand combat
When the CME began the process of stripping away over half of its 35 trading pits on July 2, it wasn’t just taking away a defining feature of the Chicago’s financial centre, but one of the city’s most popular tourist attractions. The frantic, frenzied style of trading that is a staple of the open-outcry futures pits saw traders hooting and hollering for attention, all the while throwing out bizarre hand signals that have become synonymous with the market itself. But while both insiders and outsiders alike will sadly miss the pits, the CME is after all a business and has to listen to its customers.
One of the main drivers behind CME’s decision to close pits was end users demanding access to greater levels of liquidity and transparency, along with wanting an ever-lowering of transactions costs, all of which are easily provided through electronic trading screens. But while these systems may provide access to all of the above in abundance, the one thing they will never be able to emulate successfully is the fun of the floor.
“I just enjoyed the fact that the pits were a form of hand-to-hand combat”, explained Shellady. “The sights, the sounds and smells of the pit that help you make your decisions on a guttural level rather than staring at a computer screen all day and listening to the air conditioning – its just not as fun.”
Not only do the dozens of screens that he and his colleagues now sit behind fail to offer the same buzz that they felt on the floor of the exchange, but they also fail to offer an adequate feel for the market. “There used to be a great sense to the market that you picked up just from the way the crowd reacted and it is very difficult to get that from a screen”, said Pietrzak. “The screen is a machine; a bunch of algorithms, and trying to pick up the rhythm of the market on it requires a very different skillset. You can surround yourself with dozens of screens that give you information that you never had access to down on the floor, but the buzz, the electricity in the room that was always there was something you don’t get fed off of”, he added.
Tech transparency
Traders nowadays needn’t rely on flashy trading jackets or their loud voice in order to buy low and sell high, nor do they require knowledge of the vast array of hand signals designed to communicate their position in the market. Instead, they need to adapt to the speed of electronic trading, along with the many different strategies that allow them to gain the edge in a market where transparency is abundant.
Since the financial crisis in 2008, risk-averse regulators looking to more closely monitor trading activity have acted as a catalyst for the development and proliferation of electronic trading, which is meant to offer greater market efficiency. This relatively new technology is meant to provide more proficient markets by offering greater liquidity, price transparency, and counterparty anonymity, with the trader’s identity being kept a secret to all parties, except the broker nominated to execute the trade.
But while many, including the regulators, favour the transparency offered by electronic trading, many senior traders with experience of both the pit structure and CME’s trading platform GLOBEX, assert that there is a lot of meaningful information on the floor that simply cannot be replicated electronically.
“In my opinion, the screens present less transparency”, said Pietrzak. “When you were in the pit you always knew when the guys that represent hedge funds were buying or selling and when the commercials were buying or selling. But there is almost no way to discern that now.
“I’m looking at my screen right now and I can’t tell you whether the size on the bid side is a hedge fund or an algo”, he added.
In Pietrzak’s opinion the market has traded in the thrill of the floor for not just greater efficiency of trade, but also an increased certainty of trade too. He admits that when he started on the trading floor back in 1979 that often the size of orders on the bid and offer side wouldn’t match up, causing a number of missed trades.
“You’ve effectively traded a certain amount of the transparency for knowing it was Cargill buying corn or Bunge selling wheat”, he explained. “You used to know that by who was selling the orders in the pits for making sure that all those trades and positions were checked and correct. It used to be minutes to confirm a trade, but now it occurs in terra-seconds.”
Human error
The trading floor was once the place that provided the most market colour – those precious nuggets of information that helped investors and traders get a feel for the direction the market was heading that day. The best brokers were the ones that got it right more often than they got it wrong and over time a number of trends arose that helped provide investors with a handle on the market. Old adages like Tuesday reverses a Monday or Turnaround Tuesday were successful for many people in the market.
The trading floor was once the place that provided the most market colour
But with the increased efficiency of electronic trading, offering greater certainty of price, and thus allow people to know more accurately where the market is at any given time has removed the need for such pricing proverbs. But Pietrzak hopes and asserts that losing this common sense approach to the market needn’t be lost and could even be incorporated into automated systems over time.
“Common sense was always important in the pits”, he said. “Not only that, but when you’re wrong, being able to catch yourself and turn it around. Typically machines don’t do that and once they start buying they keep buying. There are some algos that don’t do this and just take advantage of inefficiencies in the market, but the problem is that most of those systems have narrowed the inefficiencies so much that their profitability is diminishing.”
Before the shift to electronic trading human error and misinformation created a lot of inefficiencies, which added greater risk and instability to the market, something that many would like to reduce as much as possible. However, it was these same discrepancies between real and perceived market value in which many traders made their fortunes.
Ultimately, the move to automated systems will provide a far more efficient and fairer market for all, but there are concerns still about a market dominated by machines.
“When you were filling orders or you were trading for yourself and the market got away from you, you could always stop”, said Pietrzak. “You could stop trying to buy and stop trying to sell and just wait for things to settle down, but now, with all the machines all going the same way at the same time that doesn’t happen. There still has to be some human interaction with the markets to make them reliable and give confidence to the investing public that it is still a true market, not just a roulette wheel or a slot machine.”
In the end, much of the fear surrounding electronic trading and the subsequent reduction of human element posing a substantial risk to the market are unfounded. In fact, it is easily argued that behind every automated system is a person tinkering away. Meaning that the human element is still present, but instead of existing in a physical form on a trading floor is incorporated into the algorithms trading strategy in digital form.
Evolve and thrive
Regardless, of the pros and cons of electronic trading, it is the direction that the market has decided to take. Though it didn’t stop a small number of traders attempting to oppose the CME’s plans by requesting the US Commodity Futures Trading Commission (CFTC) to review the potential repercussions the move would have on the market.
Their chances of success were slim to say the least, and in reality, their efforts represented a last-ditch attempt to try and delay the inevitable.
“It was futures traders who wanted to try and keep the pits open for a few more months”, explained Shellady, “but in the grand scheme of things, more people just wanted it to be over and done with. The sooner you make the career change the better”.
The cow-coat wearing trader doesn’t just talk the talk and asserts that change needn’t be seen as a bad thing. He still has a business executing customer orders on the screen, in a similar fashion to the brokers in London. “We are going to adapt and embrace the change rather than run from it”, he added.
The spectacle of the trading floor has not gone away completely, however. The floor-based S&P 500 futures market, which continues to provide an important venue for trading the underlying futures contract for the open outcry S&P 500 options market, will remain open on CME Group’s Chicago trading floor for the time being.
But for those traders that had to say goodbye to the job they love in July, the CME showed why so many refer to it as their home from home, helping floor traders who want to continue trading by making booth space available following the closure of the futures pits.
“Anybody who has been trading in the last five years has to have known that this was coming”, said Pietrzak. “Somebody who plays golf has to adjust their game as they get older and in the same way businesses have to adjust too. People who want to not only survive, but thrive in the future have to change with the times.”
