What is a trading floor?

A trading floor refers to a literal floor in a building where equity, fixed income, futures, options, commodities, and foreign exchange traders buy and sell securities. Traders buy and sell securities on behalf of clients, and on the bank’s account. The trading floor of a stock exchange is commonly called “the pit” because of the hectic pace of events on the floor.  

 

trading floor

 

How is trading done on a trading floor?

Sales and Trading professionals on a trading floor trade using the ‘open outcry’ method. The open outcry method stands in stark contrast to the telephonic and online trading methods used in modern stock exchanges.

Trading takes place as follows:

 

Bidding and offering

Under the open outcry method, traders communicate trading information by:

  • Shouting verbal offers and bids
  • Waving arms to bring attention to their offers and bids
  • Using hand signals

The flow of activity in trading pits is fairly volatile. Trading activity is high close to the opening and closing of trading and when important changes take place in the concerned market. A runner approaching the pit with a brokerage order it met by traders who start shouting to get the attention of the concerned broker, even before the order has been given to her/him.

Since only brokers at the top of the pit can see the runner, if they become active, brokers further down the steps pick up their queue and act accordingly. Traders at the center of the pit may also spur activity on the floor. This is because they may be the first ones to see an important change in information displays, which spurs them to action and accordingly results in greater activity all around the floor.

To deal with the volatility and information overload, a dominant strategy among traders is to focus on certain trader and/or information and discount the rest.

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Creation of informal contract

A contract is arrived at when a trader announces that they wish to sell an asset at a particular price and another trader replies by saying that they will purchase the asset at the announced price.

 

Recording the deal

Given that the traders involved in a deal stand 20 to 30 feet apart from each other, both the buying trader and selling trader record the trade separately.

 

Confirmation and acknowledgment of a deal

After the trade has been confirmed by both parties, each trader’s clearing member reports their side of the deal to the clearing house. The clearing house attempts to match the two deals; until then, each side bears a non-comparison risk. If the deals are successfully matched, the two traders acknowledge each trader’s claim on the other. However, if the clearinghouse fails to match the, an out-trade is declared.

An out-trade occurs when there is:

  • a misunderstanding between the concerned traders
  • a reporting error made by clerks, key-punch operators and/or traders

Resolving out-trades is expensive but they are usually resolved in a timely manner before trading starts the next day. Till the trade is accepted, the traders have claims against each other which are unsubstantiated i.e. the deals lack a jointly written acknowledgment of the trade. Thus, many traders choose to trade with traders who have long standing relationships with them and are reputable.

 

Structure of a trading floor

The trading floor is a large room with several circular arenas known as pits. The pits have a flat center and broad steps ascending concentrically to the edge (the steps ensure that traders can see each other).  Trading is conducted in the pits.  Traders either stand in the center of the pit – facing outwards – or on the steps – facing inwards. Booths – which are assigned to brokerage firms – are situated close to pits and consist of electronic equipment (like telephones). The booths receive orders from clients and these orders are transmitted to the broker in the appropriate pit through a messenger. There are multiple devices which display information relevant to trading on the trading floor.

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Type of traders on a trading floor

The trading floor has the following types of traders:

 

Floor broker

A floor broker carries out trades on the behalf of a client, according to the orders given by the latter. Given that a floor broker works on the behalf of their client, they do not have as much decision making freedom as other professionals in the pit.

A floor broker can be:

  • A salaried employee of a brokerage firm who handles the orders of the said firm
  • An independent professional who is employed by multiple brokerages and receives a commission for her/his efforts.

Retail clients rarely contact their broker as account executives take their orders and pass them to the brokers. Active individual clients and commercial clients often contact their floor broker.

 

Scalper

A scalper is an independent trader who looks for temporary imbalances in the normal flow of orders in the pit from which they can earn a profit through the purchase and sale of assets from the own trading account. Scalpers reduce their downside risk by holding positions of a limited size. Scalpers provide ‘predictable immediacy’, liquidity and (sometimes) depth to the market as they allow other traders to finish their orders in a timely fashion and at a price which is similar to the last price – scalpers purchase at the bid price and sell at the asking price.

 

Position trader

A position trader takes a larger position than a scalper and holds the position for a longer time. A longer position results in lower turnover which in turn results in greater risk. Thus, position traders must ensure higher profit margins. There are two types of position traders – fundamental traders and technical traders. A fundamental trader makes decisions based on information about the demand and supply for the commodity or security underlying the futures contract—corn, wheat, Treasury bills, common stock prices.

Position traders carry out trades on the floor because:

  • it results in cost savings as the position trader does not have to pay floor brokerage to other traders
  • Information may be available more readily on the floor vis-à-vis off the floor

 

Spreader

Spreaders take opposing or offsetting positions in 2 or more commodities which are related to each other. They help create interlinkages between the prices in different but related markets as a result of which trading pressures in one market affect prices in a related market. This increases the complexity of particular markets. Furthermore, spreading between inactive and active markets increases the liquidity of the inactive market.

Spreading is carried out between various different markets:

  • Between different maturities of the same asset
  • Between the underlying cash market and the corresponding futures market
  • Between different types of futures markets
  • Between options and futures of a common cash commodity
  • Between options and futures on futures

 

Hedger

Hedgers are floor traders who represent a commercial firm. Hedging the act or reducing risk by taking a position in a market which is the opposite of a position in another market.

 

Specialists

A specialist is a floor broker’s broker and dealer. Specialists came into being when floor brokers started operating from specific trading locations. A specialist allows a floor broker to execute orders for assets traded at a specific location but remotely, when the conditions are right.

 

More resources and learning

We hope this has been a helpful guide to how a trading foor or orgainzed, and what takes place on a trading floor.  To continue learning, please check out these helpful resources: