DEFINITION of Pit
The pit is a specific area of the trading floor that is designated for the buying and selling of a particular type of security through the open outcry system. In the pit, brokers match customers' buy and sell orders through shouting and hand signaling. Orders are displayed via the open outcry system to all traders in the pit in order to allow the chance for anybody to participate and to let people compete for the best price. Brokers and dealers trade their clients' orders as well as may place proprietary trades for their firms. Orders that are not executed in the pit are executed through electronic trading.
BREAKING DOWN Pit
Pits, also called trading pits, have an octagon shape with several tiers to improve visibility. Brokers show their brokerage affiliations through their jacket colors and badges. Clerks take orders by phone or computer from customers, and runners transmit orders between the clerks and the brokers. Brokers and dealers may trade their shares and represent themselves, or they may work for firms and trade shares for clients or the proprietary accounts of their firms. Specialists work their own books on the floor of the pit, making a market in securities and keeping a ledger of orders awaiting execution.
In the noisy, fast-paced and chaotic environment of the trading pit, hand signals facilitate quick trading and make it possible to be "heard" above the crowd. For example, when a broker turns his palms toward his head, he is indicating a buy order, and when his palms are facing away from his head, he is indicating a sell order.
Although many proponents of the open outcry and pit environments feel that the ability to signal orders openly to a crowd and see the facial expressions of the participants creates additional market transparency, the trend in the last several years has been to move away from the open outcry system and towards electronic trading. Since the late 1980s and early 1990s, many of the world's large exchanges have made the transition. Electronic trading is cheaper to run than the open outcry system.