Basics of the Mechanics Behind Electronic Trading

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We hope you understand, and consider subscribing for unlimited online access. On January 14,it was freezing outside the non-descript office building that houses the Kansas City Board of What is the meaning of electronic trading. Inside, traders who had spent their entire careers on an open-outcry market, where business was done face-to-face, watched as their way of life was utterly transformed.

For the first time, it was possible to trade Hard Red Winter Wheat—which, as the primary component of bread, is one of the most traded commodities in the U. Skeptics, used to the old ways, had predicted that the electronic market would be unpopular. Yet the first what is the meaning of electronic trading it operated, it served ten times as many trades as the old open outcry market, and even though the trades were smaller on average, it still accounted formore trades per month—nearly double the volume of the old market.

An analysis of the transition published this year by a pair of economists from Oklahoma State University captures an increasingly rare event in the developed world: So far, the Kansas City Board of Trade has seen only the benefits that economists previously predicted would accrue to anyone who adopts an electronic market.

For example, according to the analysis by Smarth Shan and B. Wade Brorsen, moving to an electronic market meant decreased price volatility. All of this makes sense when you imagine replacing the clubby atmosphere of a trading floor packed with a few dozen guys who have known each other for decades, with a potentially infinite number of anonymous traders logging on from anywhere in the world, moving prices in tiny increments. Hear more about finance from the experts at the Business of Blockchain on April 23, in Cambridge.

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Electronic or scripless trading , sometimes called e-trading or paperless trading is a method of trading securities such as stocks , and bonds , 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.

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. 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 to identify which firm they worked for would shout and gesticulate at one another — a process known as open outcry or pit trading the exchange floors were often pit-shaped — circular, sloping downwards to the centre, so that the traders could see one another.

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. Set up in , NASDAQ was the world's first electronic stock market, though it originally operated as an electronic bulletin board [ citation needed ] , rather than offering straight-through processing STP.

By investment firms on both the buy side and sell side were increasing their spending on technology for electronic trading. 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. 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 [8]. For instruments which are not exchange-traded e. US treasury bonds , the inter-dealer market substitutes for the exchange. This is where dealers trade directly with one another or through inter-dealer brokers i. They acted as middle-men between dealers such as investment banks. 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 or "discount" brokers e. Charles Schwab , E-Trade went online during the late s 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 Xtra , Thomson Reuters Eikon , BondsPro, Thomson TradeWeb or CanDeal which connect institutional clients to several dealers , or using their brokers' proprietary software. For stock trading, the process of connecting counterparties through electronic trading is supported by the Financial Information eXchange FIX 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, [9] foreign exchange, [10] derivatives, [11] and fixed income [12] trading. 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.

Exchanges typically develop their own systems sometimes referred to as matching engines , although sometimes an exchange will use another exchange's technology e. Exchanges and ECNs generally offer two methods of accessing their systems —. 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.

Many brokers develop their own systems, although there are some third-party solutions providers specializing in this area. 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. Many types of algorithmic or automated trading activities can be described as high-frequency trading HFT , which is a specialized form of algorithmic trading characterized by high turnover and high order-to-trade ratios.

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