The hybrid market

August 19, 2007

The ASA conference finished this week. I listened to some very good papers and attended some very interesting sessions, as you can see in a recent post in Org Theory . I will cover these in more detail when I get copies of papers from presenters. This time I would like to talk about a tour we took of the New York Mercantile Exchange . Daniel Beunza, my partner in blogging here in Soc Finance, arranged the tour and it is a good opportunity to thank him publicly for an innovative step that resulted in an exciting and memorable experience. Our guide on the tour gave a nice overview of the exchange’s history, trading practices and even gave us a little tutorial in tossing trading cards to the exchange’s clerk.

This was all light-hearted and entertaining, but there was a more sombre undertone to the visit. As went through the exchange’s little museum floor, the guide continuously mentioned the fact that the trading floor used to be much busier and that that nowadays much, if not most of trading is done ‘from home’. When we got upstairs to look at the trading floor proper, it was obvious that the guide was lamenting the immanent disappearance of open outcry trading in the exchange, a process that has already started, and soon to be replaced completely by screen trading.

This all sounded very compelling, but did we really see pure outcry trading from the visitors’ gallery? A slightly more observant look showed that all traders were using tablet computers. It turns out that trading was not done only face-to-face. In addition to trading in the pit, trades also filled orders that came through their computers. These trades, it has to be mentioned, were completed anonymously. That is, traders could fill orders from the public as well as initiate trades anonymously. That is, without the knowledge of the people standing inches from them in the pit. The existence of these two separate trading routes can be used to create interesting informational manipulations. For example, a trader can split her book of order in such a way that only a fraction of the real activity is revealed publicly, and the rest is conducted in stealth, through the handheld terminal. In fact, it would not be surprising if two traders who rub shoulders in the pit would be trading anonymously with each other.

The hybrid nature of the market does not end there. From the visitors’ gallery I could see on some of the handhelds’ screens the familiar windows of portfolio management software. Again, like the automatic order routing, this is hardly surprising: if you have to carry a computer on the trading floor, you might as well run some useful programs on it. But, where does this leave the distinction between open outcry and screen-based trading? That is, the traders see the market both with their own two eyes, watching out for the tale-telling body language, the noise level and, laterally, word of mouth. In addition, they also see the market with the help of ‘x-ray goggles’ in the form of computer-based risk management.

As Fabian Muniesa would have put it, the market was already partly folded into a machine. For the traders, this form of hybrid market seems to have the best of both worlds. They receive the unmediated and irreducible information that only a live trading pit can produce: the facial expressions of one’s trading counterparty, the reactions of the pit to news, fear and greed in their naked, and most revealing forms. In addition, the handhelds provide them with different types of information: what other markets are doing, how the last trades affected the trader’s portfolio and what is the current risk picture. Combined, these two streams of information are unparallel in their richness and scope. There is little doubt that trading this way is potentially very rewarding for the traders.

Well, then, if it’s so good, why would anyone want to give it up? The answer here, like in so many other cases, boils down to one word: privatisation. The traders don’t want to go home. Although many of them do leave the floor, trade from home and do very well, many others realise that they cannot trade facing only the screen. In the tour, our guide says that she sees some of the ex-traders in Home Depot. They don’t want to go home, but the exchange is not theirs anymore and they don’t have a say about it. The NY merc, like many other exchanges was sold and the owners moved to screen-based trading. The technological dimension of the story is well known:
price determination is done much more efficiently through computer algorithm than doing so through face-to-face trading. Higher volumes of orders are processed this way and since trading volume is the lifeblood of any exchange, the decision to move to automatic order routing and quote generation is easy.

However, the tour gave us a hint about the political dimension that it embedded in that ‘purely-technological’ transfer to screen-based trading. Our guide mentioned that thinning business on the floor mean that frequently traders walk home with a profit of a few hundred dollars, not like a few years ago when ‘a trader would make $50,000 a day and then would take the rest of the week or even the rest of the month off’. So, it is not only that electronic price determination is faster; it is also important for the exchange that computers do not take days off and take off some potential liquidity with them. It is a common saying that traders are the working class of the financial world. Indeed, many of the traders in the commodities exchanges come from working class background. The move to screen-based trading seems to complete the analogy: you are part of the working class if one day they replace you with a machine.

12 Responses to “The hybrid market”

  1. danielbeunza Says:

    Fascinating handheld computers, I agree! A very ingriguing part of the visit to the NYMEX. But, to me, the visit inspired more than nostalgia.

    The real question that it raised is: if we agree that live trading conveys valuable clues about value, what type of digital interface would replicate these cues?

    The need for the cues, even with computer trading, was made clear by the tendency of retired floor traders to trade electronically together from shared spaces (rented offices). These, or the use of handhelds in the NYMEX’s pits suggest that users insist in reassembling the social dynamics of the market — in their own trading environment.

    Indeed, this push to reintroduce space seems to be the case in other digital environments — such as Second Life. The paradox, then, is that just as the Web 2.0 is introducing space into electronic trading, exchanges seem to be removing it in favor of crude digital interfaces.

  2. Peter Says:

    Daniel, your comments are really interesting. I recall going to the FIA futures expo some years back, where they were just introducing and promoting handhelds. The ‘innovative’ interface was one that actually tried to replicate a pit, with orders appearing almost in a circle rather than buy/sell lists. A few years later, these kinds of handhelds disappeared. I also noticed that electronic trading firms had stopped thinking of floor experience as a positive and more of a problem – retraining open outcry traders was more difficult.

    My interpretation was (and is) that there was a shift from elect. trying to emulate open outcry, to coming to have its own logic – this was/is a decisive problem for open outcry.

    Interestingly, per your comment, this seems to be happening independently of the ‘value’ of information in open outcry/electronic trading. Valuable clues about value, after all, are only valuable to the extent that someone is able to take advantage and press them, no? If powerful actors can’t or won’t, and don’t care, perhaps they can eliminate that channel of information with impunity?

  3. Fabian Says:

    Yuval, the downsizing argument is very important to understand any exchange “modernization” process, indeed. Disrupting any potentials for strikes (not only for large holidays) might also be an important element in a process of exchange automation (and in a context in which an “exchange” becomes a service you want to sell at good price). Is there at NYMEX some kind of tough trade union culture?

  4. another sociologist Says:

    In the tour, did they take you to the pier where they used to dump people that did not pay in the good old days?

  5. yuvalmillo Says:

    Trade unions in an exchange… this is very interesting. I just quickly checked the web sites of some of the leading commodities exchanges and could not find a sign for it. This does not mean that it doesn’t exist, of course. In fact, I know of some grassroots organisations among CBOE traders in the 90s that worked against the abolishment of open outcry. However, sociologically speaking, if such a union exists, it would be very different from workers’ union as the traders used to be the owners of the exchange and not employees. In any case, this is definitely something that’s worth a study.

    About the other comment: I’m afraid that we got a cleansed version of the exchange history (the guide was an employee of the exchange). If you have any sources about this, please let me know and I promise I will write a post about it – too good a story to miss.

  6. Peter Says:

    Fabian, you are thinking about the MATIF case, perhaps, as traders went on strike in April/May 1998? IMHO, this accounted for the shift in volume from open outcry to electronic trading as much as anything – and most of those traders, as I remember, kept positions in the new scheme.

    The cultural environment of Chicago exchanges would, I would guess, make similar collective action very difficult. People see themselves very much as part of a ‘last bastion of capitalism’ and a pure market – lots of antipathy towards unions.

  7. Zsuzsanna Says:

    Peter, interesting history of the handhelds. The larger point recalls the evolution of cell phones and varieties of vegetarian food. When I was shopping for a camera, I remember an online magazine reviewer’s introduction of the newest small (non-professional) models. The writer observed that until recently there was always a reference to the classic camera-look in the design of digital ones, but now the makers have finally embraced the idea that this is a totally different type of device and don’t even try to resemble the old non-digital cameras. So the new digital camera can look like anything (indeed one of them looked like a stick, the other like a card). The digital features are thus liberated from conforming to the classic design and the makers can focus on making the most out of the digital aspect, according to the reviewer.
    Vegetarian food: there is one line of it that makes the effort to imitate meat with less rather than more success; and there is the line that does not make this claim or effort and tries to just make great food from vegetables.
    These simplified narratives of technological change suggest that some technologies, for some reason, start out with mimicking the existing one, later break away from that, and still later might come back to elements of it (in Daniel’s comment about re-creating the benefits of space). Of course it might not be exclusive, and like with vegetarian cooking there may be alternatives running next to each other; although some can become more mainstream than others (digital clocks that show numbers and those that show a clock’s face, and mechanical clocks). I’m sure there is a huge STS literature on this.
    The implication for the exchanges might be that the story is not finished, as there may be a swing back to the situational elements of trading, a movement to somehow incorporate it into digital trading but in a novel way.

  8. Zsuzsanna Says:

    sorry, not cell phones but cameras (first sentence)

  9. hiutopor Says:

    Hi all!

    Very interesting information! Thanks!


  10. […] September 24th, 2007 Daniel, the NY link of this little London-NY collaboration, sent me this link to a NY Times article about the immanent closure of some of the physical trading floors of the New York Stock Exchange. Some of the readers of this blog came to a tour of the New York Mercantile exchange where a similar message, about the rapid move from face-to-face to screen-based trading, was conveyed (see here). […]

  11. […] Yuval wrote, what we saw at the NYMEX this past month was a remarkable a technical hybridity. Rather than the […]

  12. […] not based in the city, the biggest securities trading floor is no longer that of the NYSE (see here about the demise of open outcry trading and here more discussion about […]

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