What is a trading floor?
As the name suggests, a trading floor is a place where traders buy and sell fixed income securities, shares, commodities, foreign exchange, options, etc.
- On the trading floor, these traders buy or sell these securities on behalf of their clients or the organization that they work for.
- A trading floor looks like a circular area. It’s often called “a pit”, because when the traders trade they step down onto a certain area and buy/sell securities.
- These trading floors can be found in places where trading activities occurred. For example, we can talk about the New York Stock Exchange or the Chicago Board of Trade where traders trade on the trading floors to buy or sell.
- We can also find trading floors in investment banks, brokerage houses, in firms that are in the trading business.
- The traders buy/sell securities on the trading floors via telephone, internet, and another particular method.
How traders do trading on a trading floor?
There is a particular method that the traders follow on the trading floor. It’s called the open outcry method.
Open Outcry Method
Under this method, the traders scream, offer hand gestures to signal to attract attention.
In this section, we will discuss how to open outcry actually works. There are three ways, using which traders communicate for buying/selling securities on the trading floor.
- The most usual one is screaming from the top of their lungs and sharing the offers and the bids.
- The second type of gesture is by waving arms like crazy to get the attention of the offers and bids.
- The last type of demeanor on the trading floor is using hand signals.
As you can imagine, a trading floor is a place where you would see traders screaming, waving their arms, using their bodies like crazy, etc. It’s a place where everything happens pretty fast. And if you miss one bit, you will lose.
The trading activity reaches its peak at the time of starting and at the time of the ending. In between the trading activity is a combination of high and low energy.
As you can imagine, the trading floor is always volatile. When a trader sees a runner approaching with a brokering order, even before the order is his/hers, he starts screaming from the pit to get the attention of the appropriate broker.
The brokers can see the runner from the top of the pit. If the brokers see the runner, they become active and go down toward the pit to get the fact and then act as per the information. Traders who are standing in the pit may also act quickly to get the attention of that particular broker.
Sometimes when a trader of a particular firm knows/has an understanding that whatever he would sell would be bought by a particular trader of another firm, the former stops shouting and directly gives a sign to the latter that he wants to sell the shares of a particular stock. The former also let the latter know how many shares he wants to sell.
Informal contract on the trading floor
On the trading floor, many traders go for informal contracts. If a trader announces that he wants to sell a number of certain stocks at a particular price and another trader agrees to buy the shares at that announced price, it will be called an informal contract.
The informal contract has nothing written about it, but the basis of it is the integrity of the traders. If a trader of a firm says that he would buy a number of shares of a particular stock and veer off course at the end, it will hit the integrity of the whole firm the trader is representing.
That’s why informal contracts are taken very seriously. Since many informal contracts happen on the trading floor, not maintaining integrity may affect the stock market or the bond market adversely.
How does clearinghouse work on the Trading Floor?
When two traders agree upon a particular deal, the clearing member of each trader informs the clearinghouse about that particular deal. Then the clearinghouse tries to match the deals from both sides. If the clearinghouse is able to match the deal, two traders can claim the acknowledgment on that particular deal. On the other hand, if the clearinghouse is unable to match that particular deal, the clearinghouse declares an ‘out trade’.
An ‘out trade’ happens for two basic reasons –
- When there’s a no understanding among the particular traders
- When traders/operators/clerks make an error
No matter what happens, the ‘out trade’ is always resolved before the start of the trading day, next day. Resolving ‘out trade’ is quite expensive but it has been seen that the traders always find out a sweet-spot and solve the issue.
The fascinating thing about the claims of the traders is they don’t have a written document that can state the acknowledgment of the deal. Everything happens by the trust. Sometimes many traders only trade with traders they have a long-term relationship with because of trust issues.
Types of traders on the trading floor
It turns out that there are many types of traders on the trading floor. Here are the most prominent ones –
- Floor brokers: Floor brokers are the most common type of traders. They trade on behalf of clients. A floor broker can be an employee of the company or an independent consultant.
- Scalper: Scalper looks for temporary imbalances by using which they can buy/sell and make money.
- Hedger: Hedgers are actually floor traders that represent a commercial firm. Hedging can be done by taking a position in one market which is the opposite of a position in another market.
- Spreader: Spreaders deal with related commodities and they take an opposing position in a market to affect the prices in a related market.
- Position trader: A position trader holds a position for a longer period of time and much longer than a scalper. As a result, the risk increases. And the position trader also needs to ensure that he earns a higher profit.
This has been a guide to the Trading floor and how does a trading floor work? We also discuss open outcry, informal contracts, clearinghouse and types of traders on a trading floor. You may have a look at the following article to learn more about Trading –