Ever been to a fish market where sellers are shouting their rates and the catch of the day? While some might give you the best rates, others charge a premium for a rare fish of sorts. A similar stock market terminology is used in the financial universe where traders come down on the floor and trade their individual stocks and shares with other investors and buyers.
The people who carry out the process are none other than floor traders, and today we will take a sneak peek into their operations. Let’s hunt for some extra details on the same.
What are Floor Traders?
Floor traders are traders that quite “literally” trade on floors of the stock market. They execute operations with other traders, buyers, or investors through futures, securities, commodities, options, foreign exchange, and much more. Often floor traders are hired by companies, businesses, and other financial companies.
The physical area where the trade happens is referred to as “the pit.” It got the name from several traders accumulated in a circular space and engaged in trading activities with one another. However, the method they use in engaging trades is referred to as “the open outcry” method.
Through this method, all forms of trades are carried out where one trader screams the prices, and another trader (if prompted) buys the shares at that price. Though it might be a bit difficult to trade, it’s a system that has prevailed for centuries and continues to exist in modern stock market buildings worldwide.
How does Floor Trading Work?
As discussed earlier, the method used in executing trades is referred to as the open outcry method. Traders shout their prices, and others tend to indulge in the trade if they believe it’s a fair price. Quite the contrast compared to the electronic format of trading. Furthermore, the various steps involved in executing a floor trading protocol are given as follows:
Offering and Bidding
Under the open cry method of executing trades, traders often disclose information through the following methods.
- Usage of hand signals.
- Waving of arms to attract bids and offers.
- Shouting prices, offers, and bids.
The nature of the pits is quite volatile. There are immense shouting and perseverance of getting the highest bid possible. The trading activities are quite intensive at the time of the opening and closing of trades. Stock Brokers deliver information to the traders who start shouting the prices immediately to alter the course of trading.
But to overcome all the shouting and volatility, there are certain understandings between traders. For example, there is a trader, “Mr. X” and a trader “Mr. Y.” If any one of them wants to engage in buying or selling shares, they’ll simply look at each other silently and buy/sell stocks at the given price without interference, making it more convenient.
Informal Contract Creation
An informal contract is created when the buyer accepts the trader’s bid selling at the assets at a given price point. There is no formal contract, but just an informal way of noting down the transaction made. Every trader needs to abide by this contract and have a mutual understanding.
Understandably, the trader buying the asset and the trader selling the asset would be 20-30 feet apart. But of them make respective entries of the trade being purchased/sold separately.
Acknowledgment and Confirmation of Deal
Once both parties have created their informal contract, they are transferred to their clearing member to submit these contracts to the clearinghouse. The clearinghouse validates both the deals and compares both the written statements. If both the deals are similar, then the two traders acknowledge each other claim. If not, then an “out trade” is declared.
Things can prove to be quite expensive in an outtrade and occurs only when there is a misunderstanding between traders or reporting errors made by the trader/key-punch operator.
However, most of the traders avoid our trade as they resolved before the next day’s trading begins. To avoid outtrade, traders prefer to trade with known traders with whom they have long-term association of relations and trust.
How is the Structuring of the Trading Floor Organized?
The entire ergonomics of the trading floors are designed so that all traders are visible to one another. To do so, the primary circular area i.e. the pit is flat with circular edges where there are steps such that traders can see others. Furthermore, once trading begins, they either stand in the inner circle of the pit facing outwards or stand outside facing inwards to execute trades.
Some booths comprise telephones and other electronic communications devices that help the traders and their employer’s exchange information. The stock trader never leaves the pit, but the messages are carried out through a broker. However, to get all of the sensitive information if any trader might have missed out, television screens prompt all of the desired information.
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Types of Traders on the Trading floor
Here are some common types of stock traders you can find on the trading floor:
A person looking for temporary imbalances in the buying and selling of assets to fill their own pockets is known as a scalper. Trading is usually carried out to earn profits for themselves. They purchase assets at a bidding price and sell them at the asking price.
Floor brokers are messengers that work on behalf of their clients. They don’t have much flexibility in executing the trades of their choice. Most of the time, floor brokers are directly employed by a brokerage firm. But they can be independent brokers employed by multiple brokers and receive a commission for the trade executed.
The spreaders’ function is to influence the price and trading pressure of a position in a market by taking the opposite position in more than two commodities related to each other.
Position traders are long-term traders that look to make profits by taking the most risk. They need to have a higher profit margin, hence trying to buy assets that might increase over time. They carry out trade on the floor as it’s cost-effective, and no money is lost to the broker. The information is readily available on the trading floor.
These are brokers that execute orders from a designated remote location and are also known as the broker’s broker.
These are floor traders that represent a commercial firm. A hedger’s function is to take the position in one market by the reduction of risk, which is the opposite in another market.
Benefits of Floor Trading
- Traders can make the best of the deal, depending on the situation.
- Ease of creation of deals without any compromise.
- Information is received in exact quantitative forms.
- There is a sense of trust between traders that builds up over time, resulting in a more sensible trading option.
Though the technology might be primitive, it still is the most effective manner of executing trades in the stock market. It’s somewhat similar to live auctions where the shares’ prices keep rising depending on the number of buyers. However, making instant profits through live trading is possible, and faster negotiations for traders’ execution is a bonus.