A hybrid market is an exchange where securities are traded using electronic and traditional floor trading systems. A hybrid market offers traders the option of combining the advantages of floor and electronic trading. Floor trading refers to the transactions made by traders and brokers in person on the floor of the exchange. However, floor trading is less frequently used today because electronic trading is faster and cheaper than floor trading. Electronic trading refers to the practice of trading securities electronically, using automated electronic trading systems that execute trades automatically.
The New York Stock Exchange (NYSE) is one of the most popular examples of a hybrid market. The NYSE, one of the world’s oldest stock exchanges, functioned as a floor trading exchange until 2007. Then, in 2007, the NYSE listed its stock for electronic trading. Today, it functions as a hybrid market. In the NYSE, stocks are traded on the trading floor or electronically through online transactions.
The primary advantage of a hybrid market is that it uses both in-person floor trading and automated electronic trading systems. Both electronic trading and floor trading have their advantages and disadvantages. Using a hybrid market, investors and traders reap the benefits of both floor and electronic trading systems. Floor trading systems use the human judgment factor, which comes in handy for investors and traders making prudent decisions that require the experience of floor brokers. Electronic trading systems, the more commonly used option of the two, allows for swift transactions that are also more affordable and accurate than floor trading systems. Electronic trading systems are also very effective in preventing front running, which happens when brokers use inside information that has not yet been made public to make trades for their personal gain.
Investors and traders prefer hybrid markets because they choose between human floor trading and electronic trading systems. Although most trading today relies on electronic trading systems, a few situations involving complex trades may require in-person floor trading. A hybrid market allows investors and traders to profit from floor and electronic systems depending on the situation.
Why do Hybrid Markets use floor and electronic trading together?
Hybrid Markets utilize floor and electronic trading systems to give the investors and traders the choice of which trading system to opt for. By giving investors and traders such a choice, they opt for the trading system that is best suited to their situation. Electronic trading makes use of leading technology to facilitate automated transactions. On the other hand, floor trading relies on human insight and the accountability of brokers and traders on the trading floor to execute transactions. Although most stock trading today utilizes electronic trading systems, some situations may require the transaction to be routed through a broker on the trading floor. By utilizing advanced technology and human judgment, a hybrid market makes it easier for investors and traders to buy and sell securities in the market and leads to deeper liquidity. The New York Stock Exchange is an example of a hybrid market that uses floor and electronic trading simultaneously.
Which exchanges use Floor and Electronic Trading at the same time?
There are 3 exchanges in the world which uses floor & electronic trading at the same time.
NYSE: The New York Stock Exchange (NYSE) is the oldest and most well-known stock exchange to have adopted the hybrid mode. The NYSE traces its origins back to 1792 when a signed agreement between 24 stockbrokers first formed it. Until the year 1817, it functioned on an informal basis. In 1817, a constitution that listed the governing rules for trading was adopted and the New York Stock and Exchange Board became a formal organization. Trades were made in person by traders and brokers on the trading floor according to the governing regulations in the constitution. The introduction of technology on the trading floors in the 1960s significantly changed the trading rate. Computers and data networks made the dissemination of market information and trading data much faster, adding to market efficiency. The NYSE Hybrid Market was launched in 2007 when the NYSE listed all its stock for electronic trading. The NYSE Hybrid Market is a combination of open outcry and electronic trading. It combines leading technology with human judgment to form what they call the “high tech, high touch” trading system. By combining the human element with the advanced technological possibilities of electronic trading, the NYSE aims to provide lower volatility and better liquidity.
CME: The Chicago Mercantile Exchange (CME) is another exchange that follows floor trading even now. The CME is a centralized marketplace for the trading of futures and options. The trading floor is open from 6:00 p.m. to 5:00 p.m. the following day, Sunday through Friday. CME is also a rare example of an exchange that works almost 24 hours a day.
LME: The London Metal Exchange (LME) also has trading floors but works with a limited capacity. Before March 2020, when COVID-19 caused the exchange to close its trading floor for the first time since World War Two, closing and official prices were decided using open outcry. In September of that year, eight of the nine members who had previously traded on the floor of the London Metal Exchange (LME) returned. But the volumes remain low due to a higher preference for electronic trading.
What is the advantage of using Floor Trading?
Floor trading refers to the in-person trading undertaken by a trader directly or by a broker on the trading floor. Floor trading is useful when the trades are large and complex and require human judgment. Human judgment becomes a key element in terms of the timing and manner in which the trades are executed. For example, while making a large purchase, institutional investors or high-net-worth individuals may require the aid floor brokers to keep the news of their investment from going public. Front-running of the transaction could happen if the news of large-scale investments reaches potential competitors. Floor brokers help in such situations by looking up and locating potential competitors using their networks. Owing to their experience and specialized knowledge, floor traders also time the execution of trades so that the security price is not significantly affected. For instance, a floor broker helps monitor transactions and gradually makes the purchase if an investor decides to purchase a large number of shares in a thinly traded stock. The prices will go up rapidly if such a purchase is made simultaneously. Floor trading, therefore, helps prevent such a fluctuation in prices.
What is the advantage of Automated Electronic Systems for Trading?
Automated Electronic trading systems are computer-run software programs where transactions are executed automatically. Once the rules and regulations for transactions are programmed into these systems, the trades are automatically made. One of the main advantages of electronic trading is its speed. Trades on electronic trading systems only take less than a second to be executed. Floor trading, on the other hand, takes approximately 9 seconds. Another key advantage of automated electronic systems is that it limits the emotional factor and helps to stick to the trading plan. The emotion factor comes into play when the market participants are physically present on the trading floor to execute transactions. Emotions such as fear of loss or the desire to make more profit also lead to indiscipline on the trading floor or overtrading, where traders tend to purchase or sell shares at every perceived possibility. In an automated electronic trading system, the trades are made automatically when the preset conditions are met, without any involvement of emotions.
Why do High-net-worth Investors use floor trading?
High net worth investors tend to make large investments that be sensitive in nature, therefore requiring the expertise and services of someone who is present on the trading floor to execute the transaction. High net worth investors are individuals who have liquid assets worth above one million. Floor trading benefits such investors as it encompasses the human judgment factor. The human judgment factor that the floor brokers exercise influence and control both the timing and how the trades are made. The floor broker’s insight and experience become particularly useful when the high net-worth investor wishes to make a huge purchase. For example, the investors may want to keep the news of their purchase from going public for fear that potential competitors may try to front-run the purchase. In such situations, floor brokers help high-net-worth investors by locating potential competitors using their networks.
Floor trading is also used by investors when they require the floor broker’s expertise to time the execution of a purchase. For example, a floor broker’s market knowledge comes in handy if an investor seeks to invest in thinly traded securities. A large purchase of thinly traded stock drives the stock prices up as thinly traded stock is highly volatile. A floor broker monitors the market and gradually invests, thereby reducing the effect on stock prices. This kind of human insight is obtained only through floor trading, which is why high-net-worth investors often prefer to use floor trading.
Which one is better against Front-Run, Floor Trading, or Electronic Trading?
Front-running refers to the illegal and unethical practice of using information that has not yet been made public to trade securities for personal gain. Front-running happens when a broker or investor uses inside information about a future transaction that will bring out a significant change in the securities prices to make trades for his gain. For instance, when a client makes a significant investment, the broker, aware that such a large purchase will drive the stock prices up, may purchase some stock for himself before executing the client’s transaction. Then, after the client’s purchase is made and the prices have raised, he sells the shares he bought at a profit. This is an example of front-running where the broker used information that had not been made public for personal gain. Front-running also happens when brokers act upon the recommendations analysts give out to clients before the information reaches the clients.
The practice of front-running is illegal and unethical as the brokers use the information to execute the classified information trade. Using such inside information puts these traders and brokers at an unfair advantage. The practice of front-running also costs clients money due to the delays the brokers create in executing transactions. Acting on insider information from analysts is also unethical, as it puts the clients at a disadvantage. In reality, the firm must have the information reach its clients first.
Both floor and electronic trading have advantages and disadvantages in limiting the front-run. Floor trading helps limit front-running from potential competitors, particularly in the case of large-scale investments and purchases. In such scenarios floor, brokers use their networks to seek out potential competitors. However, the risk of the brokers themselves using classified information about a trade that is about to take place exists in floor trading. On the other hand, electronic trading does not involve the human factor. Electronic trading transactions are executed automatically when the preset conditions are met. The chances of front-running securities by a broker with inside information are, therefore, limited in the case of electronic trading. However, in electronic trading, there is no scope for seeking out potential competitors before making a large investment.
Although both floor trading and automated electronic trading have their own pros and cons in helping to prevent front-run, electronic trading is more suitable for today’s day and age. Owing to the numerous advantages and possibilities that advanced technology encompasses, more and more people are leaning towards automated electronic trading today.