Electronic trading, sometimes called etrading, is a method of trading
securities, foreign exchange or financial derivatives electronically.
Information technology is used to bring together buyers and sellers through an
electronic trading platform and network to create virtual market places. They
can include various exchange-based systems, such as NASDAQ, NYSE Arca and
Globex, as well as other types of trading platforms, such as electronic
communication networks, alternative trading systems, crossing networks and
"dark pools." Electronic trading is rapidly replacing human trading in
global securities markets. Electronic trading is in contrast to
older floor trading and phone trading and has a number of advantages, but
glitches and cancelled trades do still occur.
History For many years stock exchanges were
physical locations where buyers and sellers met and negotiated. Exchange
trading would typically happen on the floor of an exchange, where traders in
brightly colored jackets would shout and gesticulate at one another – a process
known as open outcry or pit trading. With the improvement in communications
technology in the late 20th century, the need for a physical location became less
important and traders started to transact from remote locations in what
became known as electronic trading. Electronic trading made transactions
easier to complete, monitor, clear, and settle and this helped spur on its
development. One of the earliest examples of
widespread electronic trading was on Globex, the CME Group’s electronic
trading platform conceived in 1987 and launched fully in 1992. This allowed
access to a variety of financial markets such as treasuries, foreign exchange and
commodities. The Chicago Board of Trade produced a rival system that was based
on Oak Trading Systems’ Oak platform branded ‘E Open Outcry,’ an electronic
trading platform that allowed for trading to take place alongside that
took place in the CBOT pits. Set up in 1971, NASDAQ was the world's
first electronic stock market, though it originally operated as an electronic
bulletin board, rather than offering straight-through processing.
By 2011 investment firms on both the buy side and sell side were increasing their
spending on technology for electronic trading. With the result that many floor
traders and brokers were removed from the trading process. Traders also
increasingly started to rely on algorithms to analyze market conditions
and then execute their orders automatically.
The move to electronic trading compared to floor trading continued to increase
with many of the major exchanges around the world moving from floor trading to
completely electronic trading. Trading in the financial markets can
broadly be split into two groups: Business-to-business trading, often
conducted on exchanges, where large investment banks and brokers trade
directly with one another, transacting large amounts of securities, and
Business-to-consumer trading, where retail and institutional clients buy and
sell from brokers or "dealers", who act as middle-men between the clients and
the B2B markets. While the majority of retail trading in
the United States happens over the Internet, retail trading volumes are
dwarfed by institutional, inter-dealer and exchange trading. However, in
developing economies, especially in Asia, retail trading constitutes a
significant portion of overall trading volume.
For instruments which are not exchange-traded, the inter-dealer market
substitutes for the exchange. This is where dealers trade directly with one
another or through inter-dealer brokers. This type of trading traditionally took
place over the phone but brokers moved to offering electronic trading services
instead. Similarly, B2C trading traditionally
happened over the phone and, while some still does, more brokers are allowing
their clients to place orders using electronic systems. Many retail brokers
went online during the late 1990s and most retail stock-broking probably takes
place over the web now. Larger institutional clients, however,
will generally place electronic orders via proprietary electronic trading
platforms such as Bloomberg Terminal, Reuters 3000 Xtra, Thomson Reuters
Eikon, BondsPro, Thomson TradeWeb or CanDeal, or using their brokers'
proprietary software. For stock trading, the process of
connecting counterparties through electronic trading is supported by the
Financial Information eXchange Protocol. Used by the vast majority of exchanges
and traders, the FIX Protocol is the industry standard for pre-trade
messaging and trade execution. While the FIX Protocol was developed for trading
stocks, it has been further developed to accommodate commodities, foreign
exchange, derivatives, and fixed income trading.
Impact The increase of electronic trading has
had some important implications: Reduced cost of transactions – By
automating as much of the process as possible, costs are brought down. The
goal is to reduce the incremental cost of trades as close to zero as possible,
so that increased trading volumes don't lead to significantly increased costs.
This has translated to lower costs for investors.
Greater liquidity – electronic systems make it easier to allow different
companies to trade with one another, no matter where they are located. This
leads to greater liquidity which increases the efficiency of the markets.
Greater competition – While electronic trading hasn't necessarily lowered the
cost of entry to the financial services industry, it has removed barriers within
the industry and had a globalisation-style competition effect.
For example, a trader can trade futures on Eurex, Globex or LIFFE at the click
of a button – he or she doesn't need to go through a broker or pass orders to a
trader on the exchange floor. Increased transparency – Electronic
trading has meant that the markets are less opaque. It's easier to find out the
price of securities when that information is flowing around the world
electronically. Tighter spreads – The "spread" on an
instrument is the difference between the best buying and selling prices being
quoted; it represents the profit being made by the market makers. The increased
liquidity, competition and transparency means that spreads have tightened,
especially for commoditised, exchange-traded instruments.
For retail investors, financial services on the web offer great benefits. The
primary benefit is the reduced cost of transactions for all concerned as well
as the ease and the convenience. Web-driven financial transactions bypass
traditional hurdles such as logistics. Technology and systems
Electronic trading systems are typically proprietary software, running on COTS
hardware and operating systems, often using common underlying protocols, such
as TCP/IP. Exchanges typically develop their own
systems, although sometimes an exchange will use another exchange's technology,
and some newer electronic exchanges use 3rd-party specialist software providers.
Exchanges and ECNs generally offer two methods of accessing their systems –
an exchange-provided GUI, which the trader runs on his or her desktop and
connects directly to the exchange/ECN, and
an API which allows dealers to plug their own in-house systems directly into
the exchange/ECN's. From an infrastructure point of view,
most exchanges will provide "gateways" which sit on a company's network, acting
in a manner similar to a proxy, connecting back to the exchange's
central system. ECNs will generally forego the
gateway/proxy, and their GUI or the API will connect directly to a central
system, across a leased line. Many brokers develop their own systems,
although there are some third-party solutions providers specializing in this
area. Like ECNs, brokers will often offer both a GUI and an API, and
connectivity is typically direct to the broker's systems, rather than through a
gateway. Investment banks and other dealers have
far more complex technology requirements, as they have to interface
with multiple exchanges, brokers and multi-dealer platforms, as well as their
own pricing, P&L, trade processing and position-keeping systems. Some banks
will develop their own electronic trading systems in-house, but this can
be costly, especially when they need to connect to many exchanges, ECNs and
brokers. There are a number of companies offering solutions in this area.
Algorithmic trading Some electronic trades are not planned
or executed by human traders, but by complex algorithms.
See also eCommerce
Electronic trading platform Electronic communication network
Stock market data systems Straight-through processing
Trading room 2010 Flash Crash
E-trading in Pakistan References
External links