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.