A trading floor refers to a literal floor in a building where equity, fixed income, futures, options, commodities, or foreign exchange traders buy and sell securities. Sales and Trading professionals on a trading floor use the “open outcry” method of trading. The open outcry method stands in stark contrast to the electronic, online trading methods used by modern exchanges. Trading floors are located in the facilities of stock exchanges, such as the Bombay Stock Exchange (BSE) and the National Stock Exchange.
Open outcry 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
Trading floor activity is important because the interaction of traders on an exchange floor determines the price of the financial instruments that are being traded.
How does the trading floor work?
Traders communicate on the floor of an exchange by shouting bids and offers, waving their arms to get attention, using hand signals. Trading activity on the floor is most active when the stock or commodities market opens, shortly before it closes or if a market-moving event takes place. Some traders tend to pair with certain other traders to avoid shouting to everyone on the floor.
Structure of Trading Floor
The trading floor is a circular area designed to accommodate a large number of traders and brokers physically who are there to execute trading orders as fast as possible. The circular area of the trading floor is known as the Pit. It is mandatory on a trading floor to conduct all the trading orders inside the pit. Either the traders can step in the centre of the pit to face outwards or stand on the steps to face inwards.
All the trading floors have numerous booths that are assigned to various brokers or brokerage firms they represent. These booths are equipped with electronic devices such as telephones or computers, allowing traders to receive orders from the firm or clients. The orders are communicated to the brokers in the pit by a messenger, which the brokers then execute. The trading floor has multiple devices that display trading information such as share price, volume, executed orders etc., for effective decision making.
How is trading done on a trading floor?
All the traders follow the open outcry system to execute trading on a trading floor. The steps followed by traders and brokers to trade on a trading floor are as follows:
- Bidding and Offering: The open outcry system is fairly volatile. It follows verbal communication where the traders and brokers verbally shout offers and bids. They also use hand signals to specify their intentions about the execution of the orders. The trading activity on the trading floor is the highest at the opening or the closing of the market, and the bids are affected by the key release of information, whether positive or negative. The messenger, also called a runner, takes the clients’ or firms’ orders to the traders inside the pit, who then shouts or waves the order to the broker for execution.
- Creation of Informal Contract: An Informal contract is made when there is a verbal acceptance of a bid between the trader and the broker. If the trader shouts a particular price for a security and the broker accepts the price, an informal contract is made between the two. Once an informal contract is made, the two parties must honour the contract and turn it into a legal contract.
- Recording the Deal: Once there is an informal contract between the trader and the broker, the deal is recorded. Since the trader and the broker stand 20 to 30 feet apart and the orders are continuous, they record the transaction separately from each other.
- Confirmation: After the trader and the broker execute the trade, both parties must acknowledge the deal and make it legal before the start of trading the next day. If the deal is successful and there are no misunderstandings, the deal is acknowledged. However, if there is a conflict, outtrade is declared. Once an out trade is declared, the parties must sit, discuss, and try to resolve the issue before opening the market the next day.
Types of Traders on a trading floor
Numerous types of traders execute trades on a trading floor:
- Floor Broker: A floor broker is responsible for carrying out trades and executing orders on behalf of firms or clients. The orders are given to the floor broker by the firm or the client. They do not have the authority to make decisions on their own or give advice to the firm or the client. But. they can be a salaried employee of a brokerage firm or an independent professional who works on a commission.
- Scalper: A scalper works as an independent trader who tries to make a profit from the temporary imbalances in the normal order flow. They utilise the imbalances by purchasing and selling securities using their own trading accounts. Scalpers are known to provide depth and liquidity to the market as they allow other traders to complete their orders in the required time and at a price similar to the last traded price.
- Position Trader: Unlike scalpers who take a small position, position takers execute orders that are larger in volume and hold the positions for a longer time. It results in lower turnover and comes with higher risk. Thus, position traders ensure that they have a higher profit margin to match the higher risk profile. Position traders prefer the trading floor as it results in cost-saving without the need to pay a brokerage fee to other floor traders.
- Spreader: They make a profit by taking offsetting and opposing positions in two or more commodities simultaneously. Spreaders create interlinkages across different but related markets, resulting in reading pressures that drive the price of security in the related market. Furthermore, spreading also ensures increased liquidity between active and inactive markets.
- Hedger: Hedgers represent commercial firms on the trading floor. These traders make a profit by taking a position in a specific market that contradicts the position in a related or different market. The main aim of hedgers is to reduce the risk as much as possible.
- Specialists: A specialist is not a trader but a floor broker or a dealer’s broker. Specialists help floor brokers and dealers who operate from a specific trading location and allow them to execute orders for securities traded from a remote location.
There are several types of traders on the floor, including:
- Floor brokers trade on behalf of clients, either as an employee of a trading company or an independent trader.
- Scalpers take advantage of temporary imbalances to make a profit.
- Hedgers trade on behalf of a commercial firm to hedge its position in commodities or other assets.
- Spreaders trade the price spreads between two futures contracts.
- Position traders hold a certain position for a longer period than a scalper with the aim of making a bigger profit.
- Market makers, usually banks or financial institutions, make sure the market has sufficient liquidity.