Aurora Borealis
1 January 1982 Financial Analysts Journal Volume 38, Issue 1

Electronic Trading in Futures Markets

  1. Joseph M. Burns

Futures exchanges produce or design futures contracts and process trading on those contracts. Currently, trading on each exchange is done manually, by floor brokers. But the high volume of standardized trading in many futures markets would appear to provide a favorable climate for economies of scale realizable through electronic trading—that is, trading in which orders are displayed and matched by computer.

Electronic trading could be expected to reduce substantially the cost of effecting transactions. Electronic trading would also be likely to improve the quality and dissemination of information (eliminating, in the process, the information advantages floor brokers currently have over other market participants). Each market participant would expose his limit order to all other market participants, not simply to one independent floor broker (through a brokerage firm), and each could know instantly the occurrence and price of any transaction. Reduced uncertainty about the execution price of a market order and increased information about the likelihood of a given limit order being triggered would tend to enhance prospective returns from (or reduce costs of) positions in futures contracts. The resultant increase in market participation would generate greater liquidity and thereby still better price information.

Under the current system of manual trading, executions of orders at most exchanges are bracketed in 30-minute intervals for purposes of time stamping. This fails to assure price or time priority of customers’ orders. Furthermore, when combined with dual trading (that is, trading by independent floor brokers and brokerage firms for their own accounts as well as for those of their customers), it opens the door to potential trading abuses. With electronic trading, executions of orders would probably be time stamped to the second, thereby providing a complete chronological record that would assure price and time priority and a built-in audit trail that would help curtail trading abuses.

The persistence of manual trading on all existing futures exchanges appears to be attributable to two factors. One is the interest of floor brokers in the status quo, and their reportedly large influence on exchange policies. The other is the absence of effective competition to existing futures contracts; in the absence of such competition, exchanges are not under pressure to institute electronic trading and thereby reduce market users’ transaction costs.

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