Why do they still do open outcry?

July 15, 2008 3:39 PM

Why do they still do open outcry? It would seem that there is a more efficient way to accomplish complex trade transactions than shouting and hand signals.
posted by bartleby to work & money (4 comments total)

For some markets they do use more efficient means. NASDAQ has no trading pit; it's all computerized.

But the transition from the old way to a new computerized system would be difficult and expensive and could cause problems (bugs!), and the old way works. Why fix what ain't broke?
posted by Class Goat at 4:26 PM on July 15

I was just reading about this today in the Wikipedia article on the NYSE.

"As of January 24, 2007, all NYSE stocks can be traded via its electronic Hybrid Market (except for a small group of very high-priced stocks). Customers can now send orders for immediate electronic execution, or route orders to the floor for trade in the auction market. In excess of 50% of all order flow is now delivered to the floor electronically."

posted by autojack at 4:32 PM on July 15

Some years ago, I asked the same question of a markets expert. His answer was that it was mostly tradition and show, and most of the real action was actually going on electronically. This was Australia, so it may not be universally true.
posted by outlier at 12:24 AM on July 16

Ah! Great question!!

Well, it certainly does seem like open outcry is an atavism, a throwback to an earlier era. And in many ways, at least on the surface it definitely is. But lets look a little deeper to see what's going on. I'm not going to endorse one approach over the other; each has it's merits and I'll try to present a few of the pluses and minuses.

First of all, the hand signals used [.pdf].

While the pdf is very CME specific, it does indeed present the design goals of hand signals, these being

1. Speed and efficiency
2. Practicality
3. Confidentiality

Pirrong (2003) identified three main factors influencing the decision to trade via Open Outcry or Electronic means; first, the relative liquidity differences between Open Outcry and electronic markets - they not only exist, but are measurable and may impact bid/ask spreads. I say may as papers I've read on the topic have presented mixed results; this is something we are still arguing about.

Second, the risks electronic traders face when establishing limit orders to protect their positions, on being "picked off" by floor traders . In this case floor traders can exploit their information advantage to push prices in a direction and magnitude favourable to their books.

And finally, the quality of information available to both Open Outcry and electronic traders. Several issues are of interest here, the least of which is, while on the surface both would appear to be informationally equal, floor traders will have a wealth of data gleaned by direct communication with market participants that electronic traders will lack. Of course, electronic traders may have other data not available to floor traders as well - but Pirrong didn't cite such data.

Full Citation: Pirrong, C., 2003, "Upstairs, Downstairs: Electronic vs. Open Outcry Exchanges", EFA 2003 Annual Conference Paper No. 203.

Although overseas it seems electronic trading dominates there are still pockets of Open Outcry in the United States where we're seeing the gradual emergence of hybrid, dual markets. Very curious.

There are lots of academic papers published on this topic, and most researchers agree that liquidity preferences seem to be the discriminating factor. Simply put: the larger and more liquid the market, the less likely Open Outcry will be favoured and persist.

And this question is especially interesting, as we're seeing both markets drive business to the other. For example, if I'd like to go long 60K CBOT Bond Futures options (not a bad position to take in this economic environment), putting that as a single, electronic trade ain't gonna work - price would drift up - the market will shifts against me - and a previously profitable trade is no longer viable. Breaking that up into multiple trades is the way to go, and moving those individual blocks down to a floor trader who can sniff out best price from folks on the other side of my trade will best protect my interests.

Going the other way, lots of orders can and sometimes are consolidated by floor traders, and moved to the electronic markets.

Given the liquidity differences between upstairs and downstairs traders (electronic and Open Outcry or floor respectively), it's not clear if Open Outcry will ever totally disappear.

But the evolution of the markets is damn interesting to watch, isn't it?
posted by Mutant at 3:40 AM on July 16 [3 favorites]