An interesting article

Discussion in 'Professional Trading' started by ohnotrader, Nov 8, 2005.

  1. An interesting article I found...Any feedback from the guys that trade or have traded down there.

    May 2005

    In Defense of Open Outcry
    By: Lance Weislak

    Fundamentally, the arguments of opponents of open outcry systems rely on two basic assumptions: that something newer is always better than something older, and that something computerized is always better than something done by a human. Unfortunately, these unquestioned assumptions lead some people to want to destroy some of the largest, most liquid, most efficient, and most successful trading systems in the world by replacing them with all electronic trading.

    Before we're blinded by the glitz and glamour of new technology and its army of highly polished IT consultants, it's worthwhile to take a step back and reexamine some these assumptions as well as consider some new points proponents of electronic trading never bring up.

    Let's start first by tackling some of the assumptions of the open outcry system:

    Assumption # 1: The open outcry system uses too many people; computers are cheaper.
    You may think that with all the people running around a trading floor, the open outcry system must be more expensive than electronic trading, but it isn't. In an electronic system, all the people you see on the trading floor are still present except you don't see them. They are simply sitting behind computers screens in dozens of different locations. Sure, you may save on a few dozen floor runners, but remember, the few dozen floor runners you fire at $30,000 dollars per year will end up being replaced by legions of IT consultants and engineers at $100,000 per year or more.

    Further, the majority of trading costs are due to back office and clearing work. Opponents of the open outcry system (read: IT consultants) often like to portray it as people shouting outside under buttonwood trees, writing with fountain pens, and using abacuses to keep track of accounts. Nothing could be farther from the truth. In fact, open outcry systems are already highly electronic and computerized. All of the cost savings that arise electronic trading have largely been realized in the open outcry system through the automation of back office and clearing work. The Merc itself has spent over $500,000,000 in the last decade on technology upgrades to automate all the work that could be automated.

    Assumption # 2: Trading floors are expensive.
    This is a derivative of assumption #1. Once an opponent of abolishing open outcry systems realizes that there is little savings to be had from the adoption of all electronic trading, he or she will inevitably point out how expensive it must be to keep maintain such large and expansive trading floors. In truth, if anything, having the technology and infrastructure to trade in one place is probably cheaper than having each firm set up its own trading floor with its own technology in its own office. To me, this boils down to an argument about heating and air conditioning bills. I'm sure the heating and A/C bills are high, but is it really worth it to install billions of dollars worth of new computer equipment just to save a few bucks on the ComEd bill? It's the one IRR calculation the IT consultants "forgot" to include in their presentation.

    Farther, Open Outcry systems have some advantages that all electronic ones can never replicate.

    Advantage #1: Open outcry systems contain more information and are hence more efficient than electronic ones.
    The more information that can be incorporated into a price, the more 'efficient' that price will be. In an electronic market, all you see are prices. In an open outcry system, you get to see the prices and the facial and body language of other participants. As a former trader, I can tell you that this is indeed valuable information. In the trenches the markets often run on emotions of fear and greed. Yes, the person next to you took the offer. But was he or she confident or just guessing? You can make these sorts of judgments in an open outcry system. In electronic trading, this valuable information is lost.

    Advantage #2: It's harder to collude in an open outcry system.
    Electronic trading will result in a few dominant players in each market. Gone are the locals of an open outcry system who kept the game honest. The NASDAQ scandal of 1995 shows that when the number of participants decreases, the amount of collusion increases. In this scandal, market markers called each other to keep the spread wider than in a normal market. In an open outcry system such collusion is impossible since local traders can step into markets with wide spreads and make profits.

    Finally you must remember an old CIO's axiom: all IT projects do half as much and cost twice as much as originally planned. This is if things are going smoothly. Just wait until the NYSE adopts all electronic trading only to watch commissions and costs skyrocket as people figure out how to handle this billion dollar boondoggle that's only one-third of the way complete and two years behind schedule.

    Euronext, LIFFE-- these electronic markets failed, and the streets are littered with the wet dream-like proposals of IT consultants gone wild who wish to automate the person to person act called trading. That's why these schemes never work and are doomed to failure. The lifeblood of a market is liquidity and these "all electronic" markets never get any. The reason is simple: open outcry markets work better
  2. Agree - the Interbank system is a long time proof of failure? :D