The floor of the stock exchange was once the main location for market transactions. It was home to traders and brokers who did the actual buying, selling, and negotiating on the physical exchange floor. Of course, this was before the evolution of electronic trading platforms.
Those same brokers and traders are now surrounded by computers that manage the majority of the buying and selling of stocks for their various accounts. Floor trading still exists, but it is responsible for a rapidly diminishing share of market activity.
- Open outcry was developed after the first stock exchange was founded in the 17th century.
- Few exchanges now have pit trading, moving from hand signals and verbal communication to automated systems.
- Some exchanges like the NYSE and CME still use floor trading for large companies and more complicated trades.
- Floor trading allows for showmanship and to simplify large, complicated orders.
The Open Outcry System
Open outcry was a system used by traders at all stock exchanges and futures exchanges. This method of trading became the norm after the first stock exchange—the Amsterdam Stock Exchange, now called Euronext Amsterdam—was founded in the 17th century.
Traders communicate verbally and via hand signals to convey trading information, along with their intentions and acceptance of trades in the trading pit. Signals tend to vary based on the exchange. For example, a trader on one floor may flash a signal with his palms facing outward, away from his body to indicate he wants to sell a security. Just like an auction, anyone who participates and is part of the trading pit are able to compete for orders through the open outcry system.
This system of trading may appear to be chaotic and disorganized, but it is actually quite orderly. Traders use signals to quickly negotiate buys and sells on the floor. These signals may represent different types of orders, a price, or the number of shares intended to be part of the trade. Specialists maintain a book of all open orders for a stock or for a group of stocks.
The End of an Era?
Nowadays, few exchanges actually have trading that takes place physically on the floor through the open outcry system. With many exchanges adopting automated systems in the 1980s, floor trading was gradually replaced with telephone trading. A decade later, those system began to be replaced with computerized networks as exchanges began to develop and move to electronic trading platforms.
The London Stock Exchange (LSE) was among the first in the world to move to an automated system in 1986. The Milan Stock Exchange—known in Italian as the Borsa Italiana—followed suit in 1994, with the Toronto Stock Exchange making the switch three years later.
Not only did these automated systems make the trading process simpler, they also helped traders improve on the speed of their trades. Electronic trading systems also cut down on error, reduce costs, and, more importantly, help eliminate the possibility of interference and manipulation by unscrupulous brokers and dealers.
The move to automate trading electronically also made sense because it gave retail investors the opportunity to conduct trades on their own, thus cutting out the need for brokers, dealers, and other professionals to execute trades on their behalf.
Not All Is Lost
While trading on the floor of the exchange is being quickly eroded by electronic trading platforms, the open outcry method of trading doesn't appear to be completely going away any time soon. There are still traders who work on the floor of the New York Stock Exchange (NYSE)—where some large companies still trade in the pit—as well as commodity and options exchanges like the Chicago Mercantile Exchange (CME).
Floor or pit trading through the open outcry system is still executed at the NYSE.
But with so much of the action of the trading world being executed electronically, does it really make sense to keep people in the pit? Some people believe there's a lot to lose by eliminating the open outcry method. That's because they say that electronic trading can only capture so much, while human activity on the floor reveals much more.
Proponents of the trading pit say having people on the floor can help relay the message of the pit, and can help provide an assessment of a trader's intentions behind a buy or sell move.
Trading face-to-face also helps simplify orders that are more complicated such as commodity futures or options trades. By executing these large and complex orders through the open outcry system, traders are better able to work with others to get a better price—something electronic systems can't always do.
The Bottom Line
The open outcry system has been part of the trading world since the 1600s, establishing decorum and a language that many traders had to learn in order to do their job. But that changed with the development of technology. Electronic trading may now be the norm of the industry, but it hasn't completely wiped out the open outcry system. Traders are still trading on the floor of exchanges for now. And it will probably remain that way for some time, where standing on the trading floor is still a necessary way of trading on the stock exchange