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Long before I’d ever written a single line of code here at Caplin, I spent most of the last decade as a participant in Futures markets. During this time I was a witness to the rapid evolution of futures trading platforms. This blog will look at some of the key changes in how trades were executed during my tenure, and how execution systems have adapted to meet trader needs and continuously changing market conditions. It will also look down the road at what lies ahead for futures trading platforms. But first, a quick look at what brought us to screen based trading of futures.

Background

While the use of future-like contracts is thought to date back to biblical times, one of the first speculative purchasing of such agreements was seen during the 18^th century. Japanese merchants would draft agreements to buy rice from farmers at a given price months in advance in anticipation of bad harvests (thus raising the commodity’s price). The drafts for these agreements were themselves traded as the price of rice fluctuated. Originally these trades would take place in front of a prominent merchant’s house, but eventually trading moved to official markets on the island of Dojima.

Open outcry

By the mid 20th century we had thousand of open outcry trading floors across the world; where people dressed in hideously coloured striped jackets conglomerated to trade futures (and other securities) based on a range of products, from oil to pork bellies.

By this point, futures contracts were standardized, exchange traded with trades settled via a clearing house; responsible for settling trading accounts and collecting margin, which reduced the risk for participants. The current reforms to OTC derivatives seek to emulate these qualities for improved price transparency and to reduce counterparty credit risk.

Traders in the pit

In this arena, floor traders use hand gestures to signal their bids or offers.  Hand signals were used, as an alternative to simply yelling, since it was thought that it was a better way to communicate over distance within a large set of people. For instance, buyers would motion their palms towards themselves; sellers motion palms facing outwards. Prices are shown with fingers held in the air, volumes are indicated with fingers to the chin for single digits, fingers to the forehead for multiples of ten. When the highest signalled bid price met the lowest signalled sell price, “FILLED” would be howled across the floor, supply meets demand, price is discovered. I know what you’re thinking, this sounds like a perfect system that couldn’t possibly be improved upon, well you’d be wrong…

Electronic Trading

In the early 1990s, large Exchanges such as the CME started to offer electronic trading platforms for trading derivatives in FI, FX and commodities. With the advancements in communication technology, the necessity of having a centralised location to trade was no more, and more traders chose to operate remotely.

While many would argue that there is no better place than in the trading pit for getting a feeling of market sentiment and price discovery, the reasons to migrate from open outcry to screen based trading were numerous:

• More clarity in the volume on the bid and offer
• Increased speed in processing trades.
• Complete anonymity
• Lower operating costs

The first trading platforms were simply ‘request for quote’, where clients would place an order and it would be confirmed at a later time. But soon GUIs supplied live streaming data, providing instantly tradable bid and offer prices along with the volume available for each.

Bid/Offer on an electronic trading platform

Towards the latter half of the 20^th century, many of the exchanges had consolidated, and open outcry’s popularity dwindled as screen based trading took over. The US has gone from having over a thousand exchanges to less than ten today.

While screen based trading had certainly raised the bar in terms of efficiency, by the year 2000 the act of entering an order on most trading platforms still involved several clicks and manually entering values. For some of the higher frequency traders and those reacting to news, it was imperative to speed up the process.

The Ladder

In 2001 the trading ladder was introduced. It displayed prices and volumes in a vertical grid for as many as 10 prices either side of the currently traded price, clearly depicting the depth of market.

Trading Ladder for Emini S&P

Some of the advantages that came with the ladder included:

• Single click order entry for market, limit and stop orders.
• Allowing one to set default trade sizes
• Visual representation of whether the order book “suggested” a bullish or bearish market.

Static price ladders could also be used to gauge recent movement. For example the ladder depicted above can be seen to have dropped 3 ticks since the ladder was last re-centred.

Given that orders for many instruments are done on a first come first served basis;  this means that in slow moving/range bound markets, queue positions for limit orders are vital. The ladder offers opportunities to view thinly ordered prices so one can strategically place themselves at the front of an order queue, in the hope of profiting by being the first to get filled at a price at a later point in time.

The computer game-like characteristics of the new trading platforms allowed technically savvy individuals, with little knowledge of the market they traded, to profit by quickly mastering the intricacies of the new execution systems. Meanwhile, some of the big players who had prospered in the open outcry environment were unable to adapt to the new ways of executing trades, and were squeezed out of the market.

Along with numerous advantages that came with the new platform in terms of market visibility and speed of order entry and deletion, it also became a playground for spoofers, so called for entering ‘spoof’ orders in the market. The most notorious of which was Paul Rotter aka the flipper. The uttering of his name alone was enough to send keyboards flying across a trading floor. He had a reputation for putting overly large orders in the order book to fool traders into thinking the market was heading a certain way; no sooner had they acted on their instincts than he would delete his orders and flip the market in the other direction. This behaviour in the trading pits would have resulted in the swallowing of teeth, but in the anonymous world of screen-based trading it was fair game.

Part 2 will look at advancements from 2001 to today including auto-spreaders, chart trading and algo trading facilities, as well as contemplating what might be next…

Filed under: Web trading technology |