Those iconic images of frenzied commodity trading by a hundred traders in colour-coordinated jackets flashing their hand signals and yelling frenetically are finally a part of history. The last week shut its remaining commodity trading pits because they were an anachronism. Will a similar day ever dawn for India’s archaic agricultural market yards? For farmers, that is the burning question.
Open outcry – where traders and brokers gather on a trading floor and compete for transactions through hand signals and loud shouts of the quantity and price at which they are willing to buy or sell – had its uses. Floor traders were skilled at executing large trades and other complex trades such as “stop loss” orders and “spread” trades, with minimal impact on prices. Outstanding orders in a “fast market” could be cancelled quickly since bids and offers were withdrawn when the traders lowered their hands.
The presence of other traders encouraged competition and trends could be predicted by watching each other’s behavior. Old-timers believed these factors were enough for a liquid and viable market.
The entry of electronic trading in 1984 changed the game. European exchanges were the first off the mark. Electronic trading expanded market reach by allowing anyone to be connected to it at anytime from anywhere. Trading became anonymous.
A number of factors make a market efficient. These include the speed with which information on price, volume, and news is priced into the trading; the transparency of the price-discovery process; and the fairness of order-matching. Technology helped all three. Electronic traders got real-time access to market analytics and breaking news that was not easily accessible from the pit. There was better transparency before placing an order because electronic trading systems display the “order book” (a list of the current best bids and offers), so that traders can calculate quantities offered and demanded at current prices.
Trading was cheaper because it eliminated the several layers of distribution in the pit. Now it was simply customer to market or customer to broker to market.
In the pit, liquidity was supplied by traders who had to be present even when business was limited. Since there is no physical limitation on the number of terminals connected to the electronic system, the extra competition led to better price discovery.
Technology virtually eliminated errors in recording orders and reporting trades. Neither open outcry nor electronic exchanges can completely eliminate illegal trading activity. But electronic trading was easier to regulate. Because trades are recorded accurately and in detail, regulators can monitor all transactions and spot suspicious patterns in the data.
Perhaps the greatest advantage of electronic trading was its ability to promote cross-border trading and across time zones. Electronic exchanges can also form linkages with each other. Together, this allowed global financial markets to emerge.
Electronic commodity trading in India began in 2003 through national online demutualized exchanges such as Ncdex, National Multi-Commodity Exchange, and MCX. Given the proven benefits of electronic trading, no tears were shed for traditional trading floors.
Now India’s 7,500 market yards are begging for similar deliverance. Electronic trading in market yards was first introduced by a Karnataka-Ncdex combine in 2011. After some initial resistance, the idea caught on. Today, traders and farmers in the state are looking forward to a single online market place which offers them state-wide access, transparency and reliability. Impressed by its success, the Modi government wants to introduce electronic trading in all market yards through the National Agricultural Market. Farmers are desperate for the change.
The only hurdle will be traders and brokers, who will certainly put up a fight. They love the age-old system – open-cry auction in ascending price of every heap that arrives in the market yard – because it makes cartelisation and fleecing is easy while business is only done between known parties.
But for once the tussle between electronic trading and open outcry mustn’t be allowed to drag on for decades. Too many rural livelihoods are at stake. State governments must pick up the cudgels against an archaic system that is holding farmers to ransom.
Ultimately, every market participant asks the same fundamental questions. Do I get the best possible price? How fast is my order executed? Can I get in? Can I get out, if I get in? How transparent is the system? Can I trust credit quality? Is this system reliable? From Chicago to Gulbarga, electronic trading has proved it can do the job. RIP, open outcry.