Electronic trading

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An electronic trading at the Deutsche Borse. Deutsche-boerse-parkett-ffm008.jpg
An electronic trading at the Deutsche Börse.

Electronic trading, sometimes called e-trading, is the buying and selling of stocks, bonds, foreign currencies, financial derivatives, cryptocurrencies, and other financial instruments online. This is typically done using electronic trading platforms where traders can place orders and have them executed at a trading venue such as a stock market either directly or via a broker.

Contents

Electronic trading first started in the 1970s but significant development occurred during the 1990s and again in the 2000s with the spread of the Internet. Electronic trading slowly replaced traditional floor trading and telephone trading over the following 20 years. [1]

Electronic trading can include various exchange-based systems that run the matching engine for orders, such as NASDAQ, NYSE Arca and Globex, as well as other types of trading platforms, such as electronic communication networks (ECNs), alternative trading systems, crossing networks and dark pools. [2] [3] Electronic trading has also made it possible to do algorithmic trading where computers are used to place orders into the market often at high speed such as in high-frequency trading

History

Before electronic trading, 1600–1970s

From the start of modern stock exchanges in the 1600s in Amsterdam and London, there were physical locations where buyers and sellers met and negotiated prices to buy and sell securities. By the 1800s exchange trading would typically happen on dedicated floors of an exchange. Often where traders in brightly colored jackets (to identify which firm they worked for) would shout and gesticulate at one another, a process known as open outcry or pit trading (the exchange floors were often pit-shaped – circular, sloping downwards to the center, so that the traders could see one another).

Development of electronic communications, 1970s

With the improvement in communications technology in the late 20th century, the need for a physical location became less important and together with the development in computer technology traders started to transact from remote locations in what became known as electronic trading. [4] Electronic trading made transactions easier to complete, monitor, clear, and settle and this helped spur on its development.

Set up in 1971, NASDAQ was the world's first electronic stock market, though it originally operated as an electronic bulletin board[ citation needed ], rather than offering straight-through processing (STP).

One of the earliest examples of widespread electronic trading was on Globex, the CME Group’s electronic trading platform conceived in 1987 and launched fully in 1992. [5] This allowed access to a variety of financial markets such as treasuries, foreign exchange and commodities. The Chicago Board of Trade (CBOT) produced a rival system that was based on Oak Trading Systems’ Oak platform branded ‘E Open Outcry,’ an electronic trading platform that allowed for trading to take place alongside that took place in the CBOT pits. In 1994, digiTRADE was the first company to bring securities trading to the internet, with K. Aufhauser & Company, Inc as the first client, going live with "WealthWeb" in September of 1994. [6] By June 11, 1997, digiTRADE launched interest and touch tone telephone workstations for full service brokerage firms. [7] By January 26th, 1998, LPL Financial Services had launched a broker workstation across 2,700 registered representatives. This was a complete front-back office system for stocks, options, mutual funds and annuities, digiTRADE PRO integrates a customized LPL front-end with digiTRADE's trading applications, and will allow LPL's reps to place orders 24 hours a day via the internet. [8] On August 31st, 1998, Thomson Financial Services acquired digiTRADE, the widely recognized leader of automated internet and telephone-based trading and account management services. By 1998, digiTRADE had deployed internet and telephone-based trading systems for 51 financial solutions including Bank of America, Bear Stearns, Chase Manhattan, Chubb, CitiBank, Dreyfus, First Union, LPL Financial, New York Life, T.Rowe Price and Wexford Clearing Services. [9] [10]

Internet from 2000s

With the spread of the internet in the early 2000s, a number of brokers started building electronic trading platforms to allow individual retail traders access to trade online.

By 2010s investment firms on both the buy side and sell side were increasing their spending on technology for electronic trading. [11] With the result that many floor traders and brokers were removed from the trading process. Traders also increasingly started to rely on algorithms to analyze market conditions and then execute their orders automatically.

The move to electronic trading compared to floor trading continued to increase with many of the major exchanges around the world moving from floor trading to completely electronic trading. [12]

Trading in the financial markets could broadly be split into two groups:

Consolidation, 2010s

By 2010 the majority of retail trading in the United States happened over the Internet, retail trading volumes are dwarfed by institutional, inter-dealer and exchange trading. However, in developing economies, especially in Asia, retail trading constitutes a significant portion of overall trading volume. [13] This also had some negative impacts such as the 2010 flash crash where errors in electronic trading caused a significant market crash.

For instruments which are not exchange-traded (e.g. US treasury bonds), the inter-dealer market substitutes for the exchange. This is where dealers trade directly with one another or through inter-dealer brokers. They acted as middle-men between dealers such as investment banks. This type of trading traditionally took place over the phone but brokers moved to offering electronic trading services instead.

Similarly, B2C trading traditionally happened over the phone but brokers moved to allow their clients to place orders using electronic systems. Many retail or discount brokers went online during the late 1990s and most retail stock-broking takes place online. [4]

Larger institutional clients, however, will generally place electronic orders via proprietary electronic trading platforms such as Bloomberg Terminal or Eikon or using their brokers' proprietary software.

Impact

The increase of electronic trading had some important implications:

For retail investors, financial services on the web offer great benefits. The primary benefit is the reduced cost of transactions as well as the ease and the convenience. Online financial transactions bypass traditional hurdles such as logistics. Conversely there is concern about the impact of speculation through trading, considered negatively and of potential significant damage to the real economy. [16]

See also

Related Research Articles

<span class="mw-page-title-main">Day trading</span> Buying and selling financial instruments within the same trading day

Day trading is a form of speculation in securities in which a trader buys and sells a financial instrument within the same trading day, so that all positions are closed before the market closes for the trading day to avoid unmanageable risks and negative price gaps between one day's close and the next day's price at the open. Traders who trade in this capacity are generally classified as speculators. Day trading contrasts with the long-term trades underlying buy-and-hold and value investing strategies. Day trading may require fast trade execution, sometimes as fast as milli-seconds in scalping, therefore direct-access day trading software is often needed.

A futures exchange or futures market is a central financial exchange where people can trade standardized futures contracts defined by the exchange. Futures contracts are derivatives contracts to buy or sell specific quantities of a commodity or financial instrument at a specified price with delivery set at a specified time in the future. Futures exchanges provide physical or electronic trading venues, details of standardized contracts, market and price data, clearing houses, exchange self-regulations, margin mechanisms, settlement procedures, delivery times, delivery procedures and other services to foster trading in futures contracts. Futures exchanges can be organized as non-profit member-owned organizations or as for-profit organizations. Futures exchanges can be integrated under the same brand name or organization with other types of exchanges, such as stock markets, options markets, and bond markets. Non-profit member-owned futures exchanges benefit their members, who earn commissions and revenue acting as brokers or market makers. For-profit futures exchanges earn most of their revenue from trading and clearing fees.

<span class="mw-page-title-main">Chicago Mercantile Exchange</span> Financial and commodity derivative exchange

The Chicago Mercantile Exchange (CME) is a global derivatives marketplace based in Chicago and located at 20 S. Wacker Drive. The CME was founded in 1898 as the Chicago Butter and Egg Board, an agricultural commodities exchange. For most of its history, the exchange was in the then common form of a non-profit organization, owned by members of the exchange. The Merc demutualized in November 2000, went public in December 2002, and merged with the Chicago Board of Trade in July 2007 to become a designated contract market of the CME Group Inc., which operates both markets. The chairman and chief executive officer of CME Group is Terrence A. Duffy, Bryan Durkin is president. On August 18, 2008, shareholders approved a merger with the New York Mercantile Exchange (NYMEX) and COMEX. CME, CBOT, NYMEX, and COMEX are now markets owned by CME Group. After the merger, the value of the CME quadrupled in a two-year span, with a market cap of over $25 billion.

In financial services, a broker-dealer is a natural person, company or other organization that engages in the business of trading securities for its own account or on behalf of its customers. Broker-dealers are at the heart of the securities and derivatives trading process.

An electronic communication network (ECN) is a type of computerized forum or network that facilitates the trading of financial products outside traditional stock exchanges. An ECN is generally an electronic system that widely disseminates orders entered by market makers to third parties and permits the orders to be executed against in whole or in part. The primary products that are traded on ECNs are stocks and currencies. ECNs are generally passive computer-driven networks that internally match limit orders and charge a very small per share transaction fee.

Algorithmic trading is a method of executing orders using automated pre-programmed trading instructions accounting for variables such as time, price, and volume. This type of trading attempts to leverage the speed and computational resources of computers relative to human traders. In the twenty-first century, algorithmic trading has been gaining traction with both retail and institutional traders. A study in 2019 showed that around 92% of trading in the Forex market was performed by trading algorithms rather than humans.

<span class="mw-page-title-main">Open outcry</span> Communication method on the trading floors of stock exchanges

Open outcry is a method of communication between professionals on a stock exchange or futures exchange, typically on a trading floor. It involves shouting and the use of hand signals to transfer information primarily about buy and sell orders. The part of the trading floor where this takes place is called a pit.

Electronic Broking Services (EBS) is a wholesale electronic trading platform used to trade on the foreign exchange market (FX) with market-making banks. It was originally created as a partnership by large banks and then became part of CME Group.

Best execution refers to the duty of an investment services firm executing orders on behalf of customers to ensure the best execution possible for their customers' orders. Some of the factors the broker must consider when seeking best execution of their customers' orders include: the opportunity to get a better price than what Is currently quoted, and the likelihood and speed of execution.

A commodity broker is a firm or an individual who executes orders to buy or sell commodity contracts on behalf of the clients and charges them a commission. A firm or individual who trades for his own account is called a trader. Commodity contracts include futures, options, and similar financial derivatives. Clients who trade commodity contracts are either hedgers using the derivatives markets to manage risk, or speculators who are willing to assume that risk from hedgers in hopes of a profit.

<span class="mw-page-title-main">CME Group</span> American financial derivatives company

CME Group Inc. is a financial services company. Headquartered in Chicago, the company operates financial derivatives exchanges including the Chicago Mercantile Exchange, Chicago Board of Trade, New York Mercantile Exchange, and The Commodity Exchange. The company also owns 27% of S&P Dow Jones Indices. It is the world's largest operator of financial derivatives exchanges. Its exchanges are platforms for trading in agricultural products, currencies, energy, interest rates, metals, futures contracts, options, stock indexes, and cryptocurrencies futures.

Direct market access (DMA) is a term used in financial markets to describe electronic trading facilities that give investors wishing to trade in financial instruments a way to interact with the order book of an exchange. Normally, trading on the order book is restricted to broker-dealers and market making firms that are members of the exchange. Using DMA, investment companies and other private traders use the information technology infrastructure of sell side firms such as investment banks and the market access that those firms possess, but control the way a trading transaction is managed themselves rather than passing the order over to the broker's own in-house traders for execution. Today, DMA is often combined with algorithmic trading giving access to many different trading strategies. Certain forms of DMA, most notably "sponsored access", have raised substantial regulatory concerns because of the possibility of a malfunction by an investor to cause widespread market disruption.

In finance, a dark pool is a private forum for trading securities, derivatives, and other financial instruments. Liquidity on these markets is called dark pool liquidity. The bulk of dark pool trades represent large trades by financial institutions that are offered away from public exchanges like the New York Stock Exchange and the NASDAQ, so that such trades remain confidential and outside the purview of the general investing public. The fragmentation of electronic trading platforms has allowed dark pools to be created, and they are normally accessed through crossing networks or directly among market participants via private contractual arrangements. Generally, dark pools are not available to the public, but in some cases, they may be accessed indirectly by retail investors and traders via retail brokers.

An indication of interest (IOI), sometimes expression of interest (EOI), is an expression in finance that demonstrates a buyer's non-binding interest in buying a security in the stock market, often before it is available for purchase. IOIs are not required, but when a firm decides to issue one, they are primarily used on two occasions: before an IPO, and before an institution places a block trade.

<span class="mw-page-title-main">Electronic trading platform</span> Software for trading financial products

In finance, an electronic trading platform also known as an online trading platform, is a computer software program that can be used to place orders for financial products over a network with a financial intermediary. Various financial products can be traded by the trading platform, over a communication network with a financial intermediary or directly between the participants or members of the trading platform. This includes products such as stocks, bonds, currencies, commodities, derivatives and others, with a financial intermediary such as brokers, market makers, Investment banks or stock exchanges. Such platforms allow electronic trading to be carried out by users from any location and are in contrast to traditional floor trading using open outcry and telephone-based trading. Sometimes the term trading platform is also used in reference to the trading software alone.

Flash trading, otherwise known as a flash order, is a marketable order sent to a market center that is not quoting the industry's best price or that cannot fill that order in its entirety. The order is then flashed to recipients of the venue's proprietary data feed to see if any of those firms wants to take the other side of the order.

MT4 ECN Bridge is a technology that allows a user to access the interbank foreign exchange market through the MetaTrader 4 (MT4) electronic trading platform. MT4 was designed to allow trading between a broker and its clients, so it did not provide for passing orders through to wholesale forex market via electronic communication networks (ECNs). In response, a number of third-party software companies developed Straight-through processing bridging software to allow the MT4 server to pass orders placed by clients directly to an ECN and feed trade confirmations back automatically.

<span class="mw-page-title-main">Interactive Brokers</span> American financial services firm

Interactive Brokers LLC (IB) is an American multinational brokerage firm. It operates the largest electronic trading platform in the United States by number of daily average revenue trades. The company brokers stocks, options, futures, EFPs, futures options, forex, bonds, funds, and some cryptocurrencies.

<span class="mw-page-title-main">Tradeweb</span> American financial services company

Tradeweb Markets Inc. (Tradeweb) is an international financial technology company that builds and operates electronic over-the-counter (OTC) marketplaces for trading fixed income products, ETFs, and derivatives. Its customers include banks, asset managers, central banks, pension funds and insurance companies. Tradeweb's headquarters are in New York City.

<span class="mw-page-title-main">Securities market participants (United States)</span>

Securities market participants in the United States include corporations and governments issuing securities, persons and corporations buying and selling a security, the broker-dealers and exchanges which facilitate such trading, banks which safe keep assets, and regulators who monitor the markets' activities. Investors buy and sell through broker-dealers and have their assets retained by either their executing broker-dealer, a custodian bank or a prime broker. These transactions take place in the environment of equity and equity options exchanges, regulated by the U.S. Securities and Exchange Commission (SEC), or derivative exchanges, regulated by the Commodity Futures Trading Commission (CFTC). For transactions involving stocks and bonds, transfer agents assure that the ownership in each transaction is properly assigned to and held on behalf of each investor.

References

  1. ↑ Ian Salisbury and Geoffrey Rogow (September 25, 2008). "Gliches Cancel Electronic Trades". The Wall Street Journal. p. D3.
  2. ↑ Lemke & Lins, Soft Dollars and Other Trading Activities, Chapter 2 (Thomson West, 2015-2016 ed.).
  3. ↑ Jya, Wak (31 August 2016). "Different Types of Forex Trading Platforms, Which the Best ?". FXdailyReport.Com. Retrieved 29 October 2016.
  4. 1 2 Graham Bowley (January 1, 2011). "The New Speed of Money, Reshaping Markets". The New York Times . Retrieved July 8, 2012.
  5. ↑ "Growth of CME Globex Platform: A Retrospective". CME Group. Retrieved October 4, 2012.
  6. ↑ "Welcome to digiTRADE -- A Thomson Financial Business Unit". 2000-08-29. Archived from the original on 2000-08-29. Retrieved 2024-02-18.
  7. ↑ "Welcome to digiTRADE -- A Thomson Financial Business Unit". 2001-01-24. Archived from the original on 2001-01-24. Retrieved 2024-02-18.
  8. ↑ "Welcome to digiTRADE -- A Thomson Financial Business Unit". 2001-04-19. Archived from the original on 2001-04-19. Retrieved 2024-02-18.
  9. ↑ "Welcome to digiTRADE -- A Thomson Financial Business Unit". 2001-04-10. Archived from the original on 2001-04-10. Retrieved 2024-02-18.
  10. ↑ "Thomson to buy digiTrade". CNET. Retrieved 2024-02-18.
  11. ↑ "ISITC 2011 Member Survey" (PDF). March 12, 2012.
  12. ↑ Jain, Pankaj K., 2005, “Financial market design and the equity premium: Electronic vs. floor trading,” Journal of Finance volume 60, issue 6, pp. 2955–2985.
  13. ↑ "The Modern Trader: A Report on the 9.6 Million Online Traders – BrokerNotes". BrokerNotes. 2017-08-17. Retrieved 2017-08-24.
  14. ↑ Harris, Larry (March 2013). "What to Do about High-Frequency Trading". Financial Analysts Journal. 69 (2): 6–9. doi:10.2469/faj.v69.n2.6. ISSN   0015-198X. S2CID   153935520.
  15. ↑ Budish, Eric; Cramton, Peter; Shim, John (2015-11-01). "The High-Frequency Trading Arms Race: Frequent Batch Auctions as a Market Design Response". The Quarterly Journal of Economics. 130 (4): 1547–1621. doi:10.1093/qje/qjv027. hdl: 1814/38326 . ISSN   0033-5533.
  16. ↑ Ryan, John A (1902). "The Ethics of Speculation". International Journal of Ethics. 12 (3): 335–347. doi:10.1086/intejethi.12.3.2376347. JSTOR   2376347. S2CID   143227107.
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