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Fair, Open & Transparent Markets
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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