ETrading
From Wikipedia, the free encyclopedia
eTrading (or e-Trading) is how people in the financial services industry refer to electronic trading - i.e. trading securities (such as stocks and Bonds), foreign currency, and exchange traded derivatives electronically.
This article refers mostly to the software design and implementation aspects of e-trading. For an introduction of the underlying algorithms and techniques, please see the article on algorithmic trading. Readers may also find the article on technical analysis useful.
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[edit] Background
There are, broadly, two types of trading in the financial markets:
- business-to-business (B2B) trading, often conducted on exchanges, where large investment banks and brokers trade directly with one another, transacting large amounts of securities, and
- business-to-client (B2C) trading, where retail (e.g. individuals buying and selling relatively small amounts of stocks and shares) and institutional clients (e.g. hedge funds, fund managers or insurance companies, trading far larger amounts of securities) buy and sell from brokers or "dealers", who act as middle-men between the clients and the B2B markets.
While the majority of retail trading probably now happens over the internet, retail trading volumes are dwarfed by institutional, inter-dealer and exchange trading.
Typically, the price of a security is set on an exchange (largely by the laws of supply and demand). For example, if a client wants to buy a particular stock that's traded on the NYSE, their broker will have their trader on the exchange floor find out the current "quote" (or, more likely, they'll read the price off a screen). They'll then add a few cents to the price they quote back to the client (those few cents is how the broker makes his profit). If the client decides to trade, the broker will pass the order to the trader to be actually filled (i.e. bought or sold).
Before the advent of e-trading, exchange trading would typically happen on the floor of an exchange, where traders in brightly coloured 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). Open outcry trading has largely been replaced by screen-based electronic trading, although a few exceptions remain (e.g. NYMEX, NYSE).
For instruments which aren't exchange-traded (e.g. 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.e. companies like BGC Partners and Garban, who act as middle-men between dealers such as investment banks). This type of trading traditionally took place over the phone but brokers are beginning to offer etrading services.
Similarly, B2C trading traditionally happened over the phone and, while much of it still does, more brokers are allowing their clients to place orders using electronic systems. Many retail (or "discount") brokers (e.g. Charles Schwab, E*Trade) went online during the late '90s and most retail stock-broking probably takes place over the web now.
Larger institutional clients, however, will generally place electronic orders via proprietary ECNs such as Bloomberg or TradeWeb (which connect institutional clients to several dealers), or using their brokers' proprietary software.
[edit] Impact
The increase of e-trading has had some important implications:
- Reduced cost of transactions - By automating as much of the process as possible (often referred to as "straight-through processing" or STP), costs are brought down. The goal is the reduce the incremental cost of trades to as close to zero as possible, so that increased trading volumes don't lead to significantly increased costs. This has translated to lower costs for investors.
- Greater liquidity - electronic systems make it easier to allow different companies to trade with one another, no matter where they are located. This leads to greater liquidity (i.e. there are more buyers and sellers) which increases the efficiency of the markets.
- Greater competition - While etrading hasn't necessarily lowered the cost of entry to the financial services industry, it has removed barriers within the industry and had a globalisation-style competition effect. For example, a trader can trade futures on Eurex, e-CBOT or LIFFE at the click of a button - he doesn't need to go through a broker or pass his orders to a trader on the exchange floor.
- Increased transparency - Etrading has meant that the markets are less opaque. It's easier to find out the price of securities when that information is flowing around the world electronically.
- Tighter spreads - The "spread" on an instrument is the difference between the best buying and selling prices being quoted; it represents the profit being made by the market-makers. The increased liquidity, competition and transparency means that spreads have tightened, especially for commoditised, exchange-traded instruments.
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 and delivery.
[edit] Technology & systems
Etrading systems are typically proprietary software, running on COTS hardware and operating systems, often using common underlying protocols, such as TCP/IP.
Exchanges typically develop their own systems (sometimes referred to as matching engines), although sometimes an exchange will use another exchange's technology (e.g. e-cbot, the Chicago Board of Trade's electronic trading platform, uses LIFFE's Connect system), and some newer electronic exchanges use 3rd-party specialist software providers (e.g. the Budapest stock exchange and the Moscow Interbank Currency Exchange use automated trading software originally written and implemented by FMSC, an Australian technology company that was acquired by Computershare, and whose intellectual property rights are now owned by OMX.
Exchanges and ECNs generally offer two methods of accessing their systems -
- an exchange-provided GUI, which the trader runs on his desktop and connects directly to the exchange/ECN, and
- an API which allows dealers to plug their own in-house systems directly into the exchange/ECN's.
From an infrastructure point of view, most exchanges will provide "gateways" which sit on a companies' network, acting in a manner similar to a proxy, connecting back to the exchange's central system.
ECNs will generally forego the gateway/proxy, and their GUI or the API will connect directly to a central system, across a leased line.
This author is no expert on brokerage systems, but as far as he is aware, most brokers develop their own systems, although there are some third-party solutions providers specialising in this area (e.g. Trayport in the commodities markets). Like ECNs, brokers will often offer both a GUI and an API (although it's likely that a slightly smaller proportion of brokers offer an API, as compared with ECNs), and connectivity is typically direct to the broker's systems, rather than through a gateway.
Investment banks and other dealers have far more complex technology requirements, as they have to interface with multiple exchanges, brokers and multi-dealer platforms, as well as their own pricing, P&L, trade processing and position-keeping systems. Some banks will develop their own etrading 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 who offer solutions in this area - Ion and GL Trade are just two examples.
The principal author of this article works in etrading for the fixed income, fx and commodities division of a large investment bank and it is his opinion that etrading is currently one of the most exciting and interesting areas to work in financial services technology.
