Dr. Joe does electronic trading - Part I
I have promised this many people shortly after my first Dr. Joe post and started it a few times but could not get it finished because I couldn’t find all my notes, paperwork etc. The Easter recess has given me time to get some of my stuff together.
From Dr. Joe’s visit to CME, we know a little bit about what went on in the Futures/Commodities pits at CME in the early 90s. Before we move on to the crazy 21st Century world of trading with electronic wizardry and gadgetry, we need to understand how we worked with our brokers at that time.
In the late 80s and early 90s BC (Before Computers) when we were drawing our own charts, doing our own indicator calculations and drawing indicators ahead of charting packages, we had a similar mechanical order placing process. Once we had decided on a trade, we had to place our order with our broker. We would call our contact at the broker (or fax, in my case, when I was living and working overseas) and give him our trade. Even though the broker knew what we meant, we still had to speak “their lingo”, so we had to say something like “Account abc123, Long 1 March Deutschemark at 2.1020 or better”. The broker would then give us a ticket number which we recorded in our files.
The broker would then send our order, now with a ticket number, to either their “runner” at the exchange who in turn would give it to their assigned trader in the pit, or send direct to their trader in the pit depending on the size of the broker.
The pit trader would read the order and try and find a seller to take the other side of the trade. Remember, this is a ZERO SUM BUSINESS, someone wins and someone loses – always. The pit trader would find a seller with his “hue and cry” by screaming and shouting and waving his arms frantically until another pit trader screamed, shouted and waved back with a price. That price was then recorded on the ticket number and sent back to your broker. Now, depending on your broker and how big of an account you were at your broker, he would either call you back immediately with your “fill” or wait for later to do all his calls.
So then hours later, in my case, I would be notified of my “fill” against my ticket number which was duly recorded in my files. Sometimes I wouldn’t get my “fill” until a day later and after receiving the previous day’s data. Talk about “trading blind”
After receiving our “fill” we would then call the broker with our Stop Loss order. “Account abc123, Short 1 March Deutschemark at 2.0020 on a Stop.”
When it was time to get out of our position, we had to do the same thing again. Call the broker, “Account abc123, Short 1 March Deutschemark at the market.” In those days, and still with Futures and Commodities, you had to take the opposite of your original position to Close your order. The same routine then happened with the broker and their pit trader until eventually, they would get back to you with your “fill”. Because of all this “mechanical” delay, your fill would be nothing like you expected and often times when you were expecting a small profit or break even, your “fill” would be at a loss.
In those days, the “little trader” really got stuffed between the brokers and the pits because we were a “nuisance to them”. Our little “1 contracts” were a pain in the armpit to them and the pit trader would always put these “little” orders to the bottom of his pile while he focused on the huge orders from the “big boys”.
Instead of adding an extra “1 contract” to the big boys’ fills, which would have been at far better prices, the pit traders would wait while they had cleared all the orders and then start on ours. This meant that we would ALWAYS get the worst fills – our fill price would always be far away from our original price. Trying to use Limit Orders was a joke for exactly the same reason and they would never get filled.
We had to keep meticulous records because there were so many errors and mistakes in those days. Most of the errors would be on our part where we would have extra positions still open because we would have not closed our open positions correctly. This got real crazy when you were trading different currencies and commodities.
Now fast forward to the 21st Century AC (After Computers). I am indebted to this information from a Professional Trader of some 40 years trading vintage who visited the CME Exchange many times through his golf buddies who were either floor traders or in some way connected with the Exchange. I thought this information was from a couple of years ago but when I eventually found my notes, it was from 2005. How I wish my trading account grew as fast as my idea of a couple of years did!
His initial observation in visiting the Exchange was one of shock. He had seen the Exchanges and Pits on TV many times and thought he knew what to expect.
Like all of us, I guess, he envisaged a very busy open pit for futures trading but what he didn’t expect was the size of the Exchange Floor with hundreds of people each sat in front of a wall of computers!
On closer inspection, each Market Maker had 30 or 40 monitors on his “wall” all linked together so that he could access each individual screen with a touch of his mouse. He was just absolutely amazed that one person could follow what was happening on so many monitors as he personally, had difficulty following his 3 monitors and still retain his sanity!
What really surprised him was that there were very few charts, sometimes none at all, on the monitors. What was on just about every monitor was price, price activity, buying and selling pressure and other information related to price. “What were these guys doing with all that information?” he wanted to know. Well, 10 years or so later from Dr. Joe’s visit, with the latest computer hardware, software, electronic wizardry and gadgetry, these guys are not doing anything any different to what Dr. Joe observed. They are WATCHING and REACTING to PRICE.
The big difference now is technology. The data shown on each monitor is integrated and networked into other computers and their software which automatically responds to changes in volatility, bid and ask spreads, volume spikes and abnormalities, exceptional order quantities, institutional trades, Government Bank trades and everything and anything influencing price activity.
For example, if volatility changed on a particular instrument, the percentage increase or decrease was immediately reflected in the Market Makers bids and asks automatically without any human input whatsoever. Similarly, and at the same time, if there were bids and asks which were incorrectly matched or “discounts” based on their software, trades were instantly and automatically initiated by the software based on the programming and parameters set by the Market Maker.
The Market Makers have their plans programmed into their software so that when all the criteria are met, their software takes over and issues the trade. This then highlights the importance of the trading plan. Where ours is mechanical, theirs is fully automated.
So, the bottom line has not really changed, the Floor/Pit traders/Market Makers are still “piggybacking” on what the market does – buy when price goes up and sell when price goes down – it’s just that now, they have very sophisticated computers and software to give them advanced notice and automatically place their trades for them.
Understanding what we are up against, (the big boys with their sophisticated hardware and systems), confirms how difficult it is (not impossible) for the little trader and how important it is for us to thoroughly know and understand PRICE ACTION and trade WITH the big boys (not against them).
In Dr. Joe does electronic trading – Part II, we will discuss the role Brokers and Exchanges play in Forex.