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The following is an essay I wrote for my newsletter today:
There are certain tenets of electronic trading that are often
recited by brokers, traders and exchanges. One of them is that
electronic trading levels the playing field for all traders. You no
longer have to be over six foot tall, a Type A personality with an
above average dose of testosterone and standing in a trading pit to
have access to the best prices and quantities, they say. Now anyone
in front of a keyboard has equal access to the market, they claim.
While that is correct theoretically, in practice not every trader is
created equal. Some traders are just plain faster to the market due
to computer power, bandwidth or automated price injection models
they are using. They utilize the latest technology and bandwidth to
pump orders in and out of the markets faster than most humans can
respond. They have sophisticated algorithms that calculate their
bids and offers on multiple systems all at the same time. A market
maker in the Mini Dow, who I mentioned in my last FutureSource
Fastbreak commentary, can run up to 10 different trading systems,
each with distinct algorithms, all at the same time.
The market maker's orders in and out of the Mini Dow are typically
logged/timed at about .25 of a second. His automated option model
scans the market for juicy opportunities and snaps them up without
him even having to touch a mouse or toggle a switch. His option
model will also automatically hedge his option deltas in the futures
as well. There is still a human override factor used when his
market making software get the wrong way in a market, but most of
the trading is automated.
The market-making firm has developed its own front end trading
software, after trying systems from various vendors, to give them a
competitive advantage. They have built stripped down software that
gives them just the functionality and speed they need.
What these electronic market makers are doing is providing
tremendous liquidity to the markets and interlinking pools of
liquidity as never before. They lean on the deep pools of liquidity
with high correlations and translate that liquidity into other
markets. For example, the Mini Dow market maker might lay off a
trade he takes in the Mini Dows in the Emini S&Ps because the
relationship is out of line relative to his correlations.
For the average trader, there is no competing with this trader on a
speed basis. However, positioning is everything. Most of today's
electronic markets use a first in first out algorithm. That means
that if your order was in first, you get the first trade that
matches up at that price level. Be careful of markets where some
market makers are given trade allocation preferences based on
joining the best bid or offer and providing continuous two sided
markets. You may be first, but that does not mean you get all of an
order filled even if you were first.
Another tenet of electronic trading is that trading is that it is
transparent. This normally means that as an electronic trader you
can see the bids and offers that make up a market.
Take a look at http://eaglei.cme.com:443/index.html to see the
transparency now available to those wanting to trade the CME's
Eurodollar contract.
Even in the trading pit, where there is a transparency to who is
bidding or offering, traders don't get to see the aggregation of
bids and offers below and above the market. However, even with this
apparent transparency there are differences for traders to
consider. For example, Eurex's trading platform offers snap shots
of the bids and offers in the match engine every 1 second or less.
What this means is that you are not seeing every bid and offer roll
by, but a snap shot of the book of bids and offers.
The match engine at Euronext.liffe that is now being used by the
Chicago Board of Trade and the Tokyo International Financial Futures
Exchange, Liffe Connect, offers dynamic streaming prices.
What these streaming dynamic prices mean to sophisticated electronic
traders is that they can read the bid and offer size and
strategically interact with the market based on the sizes
displayed. For example, some traders may take a look at the size of
the bid or an offer before releasing a stop whose price level has
been elected. The trader may have his trading platform to not send
a stop if the order size is greater than a certain quantity. Rather
than just banging out the stop because the stop price is hit, the
streaming prices and transparent order book allows traders to inject
nuances like this into their trading strategies.
Despite all this automation that some traders are using, it is not
necessary to be a successful electronic trader. It just means you
need to have a slightly different trading style, time frame focus or
skill set. The Chicago Mercantile Exchange's new Globex Learning
Center was built to help transition current traders from the trading
floor, but also to help develop the next generation of traders.
For a virtual tour of the GLC, click here:
http://www.cme.com/edu/etc/glcvirtual6466.html
The traders that will train in the GLC will be able to practice
trading in what looks like a real trading room you would find at a
brokerage firm, hedge fund or trading arcade. There are live quotes
and charts to interact with as well as new feeds blaring. Traders
in training will have their choice of 13 different Independent
Software Vendors trading platforms to choose from. They will be
able to find the system they like the best and then practice with it
with real time prices, but play money.
Another tenet of electronic trading is that it will force
traditional open outcry exchanges to close their trading floors.
Certainly the recent news that the Chicago Board of Trade had leased
its 1930s trading floor, at the foot of LaSalle Street, was an
indication that beckoning future had arrived. But the CBOT was not
using that antiquated trading floor anymore. The now shuttered
MidAmerica Commodity Exchange last used the 1930 trading room.
There is nothing for sure about closing down the trading floors,
despite what I might think or other commenter on the subject. In
fact, today's trading floors are evolving into exchange run trading
arcades where just as much electronic trade may originate as open
outcry trade. The slow migration of futures options trading to
electronic trading in the U.S., is an indication the trading floors
still have a role.
The evolution of the trading floor, and electronic trading, has
never been better represented than by the new ground floor Visitor's
Center at the Chicago Mercantile Exchange. The new interactive,
multi-media attraction tells the story of the CME's development from
a butter and egg exchange on a street corner to the U.S.'s largest
futures exchange today.
Just last Friday the CME traded over 5 million futures contracts for
the first time, excluding on days when they launched their unique
TRAKR contracts. They traded over 2 million contracts on Globex for
the first time on that same day. Yesterday they traded over 2
million on Globex again, setting another new Globex daily volume
record.
In the CME's new Visitor's Center, they have a picture of the
exchange's trading floor from some years back when they traded 5,000
contracts on a particular day. That was described in the photo
legend as a particularly busy day. Yesterday, late in the day, as
the CME was setting a new Globex volume record with every trade, the
volume was growing by some 5,000 contracts per minute.
What was once a busy day is now a busy minute. The playing field is
leveler, the trading tools are more powerful and readily available,
the trading is faster and the growth potential for futures trading
continues to be substantial.
Regards,
John J. Lothian
Disclosure: Futures trading involves risk, lots of it!
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