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NYBOT Plans to Close Trading Floor - The End of an Era

Commodities / Financial Markets Jan 24, 2008 - 12:13 PM GMT

By: George_Kleinman

Commodities

“They're not just getting rich…they're getting even”--Trading Places [1983]

There's an electric tension in the air as our heroes, Louis Winthorpe III and Bill Ray Valentine, muscle their way through the crowd of traders lining the New York Board of Trade's (NYBoT) frozen concentrated orange juice (FCOJ) trading pit. The traders are nervous with the anticipation of what's to come, sweating from the heat generated by more than 100 tightly packed bodies. The clerks manning the phones surrounding the pit are on high alert. 


The crop report is going to be released in just minutes. When the numbers are out, the market is going to move big time, creating and destroying fortunes in the process.

Winthorpe and Valentine are now standing shoulder to shoulder with other traders eyeing their arch nemesis, the slime ball Clarence Beeks.

Beeks believes he already knows the actual crop report numbers. He illegally obtained an advance copy of the report in his quest to corner the orange juice market on behalf of the infamous Duke Brothers. However, our heroes learned of Beeks' plan, managed to steal the real crop report back from Beeks and secretly delivered him a fake version.

The real crop report will show a record-large orange harvest resulting in huge supplies that will ultimately cause the traders to yell “SELL.” Beeks, believing the numbers in his false report, will be looking for the orange crop numbers to be sharply lower and is planning to cry out “BUY” in his quest to corner the orange juice market for the Dukes.

Futures are traded on margin with only a small deposit required to buy a large amount of an asset. It's also just as easy to sell first and then buy back later (hopefully lower) as it is to be a buyer. Commodities can be very volatile, particularly on crop report day.

The opening bell rings and immediately the decibel level explodes. All trades in the pit are made by “open outcry,” an auction process where the traders yell out their bids and offers, and Beeks starts hitting all the offers, screaming “BUY, BUY, BUY.”

Most of the traders in the pit are merely sheep looking to hop on for the ride and believe he knows something because he's bidding the market up, so they join him in his buying frenzy. The rumors have started to fly: The Duke Brothers (with Beeks as their agent) are looking to corner the market.

FCOJ prices are now on a tear, rising as high as $1.45 per pound. Up until now, Winthorpe and Valentine have been lying in the weeds, and with perfect timing, they begin screaming “SELL, SELL, SELL.” The true crop report numbers are then revealed, the market begins to crash and at the optimal low point of 29 cents per pound, our boys reverse course and start screaming “BUY, BUY, BUY.”

They're now covering their short sales, the majority of these sales made from well above a buck a pound, covering from 25 cents up to 46 cents and netting millions in the process. The Dukes, having bought near the top, are left holding the bag.

The classic 1983 comedy Trading Places is one of my all-time favorites. Winthorpe is superbly portrayed by Dan Aykroyd as a rich commodity broker turned homeless, with Valentine--played by comic genius Eddie Murphy--as a homeless man turned into a rich commodity broker. 

Some people believe the story was inspired by the silver market's incredible rise and ultimate fall in 1980 when the Hunt brothers of Texas tried unsuccessfully to corner that market. Silver prices crashed in March of that year when the brothers were unable to meet a $100 million margin call.

The unsung star of Trading Places was the trading pit itself, the actual pit at the NYBoT where real traders played themselves in the movie. The climatic scene (in most viewers' minds) is without a doubt the chaotic buying frenzy that took place in the pit, although some viewers might argue it was when Jamie Lee Curtis took off her sweater.

In any case, if not for the trading pit, the movie wouldn't have been as visually exciting or nearly as suspenseful. It's hard to imagine the excitement if our heroes were just clicking a mouse in front of a computer screen.

Trading Places is now more than 25 years old. The NYBoT, the exchange where coffee, cocoa, sugar and, yes, FCOJ is traded is 137 years old. (It was established in 1870.)

Now here comes the sad part: On Dec. 13, 2007, the NYBoT voted unanimously to permanently close the trading floor, moving 100 percent of the trading in these commodities over to the computer screen. Open outcry trading, the backbone of the exchange for more than 100 years, will be permanently silenced in just a few weeks in early February.

It's progress, but the pit closing will put 1,000 traders and support staff out of work. One veteran pit trader told the New York Post, “Most of these people really don't know how to do anything else, and now we will all have to find our place in the world.”

However, other than these people, the closing will have little to no effect on the dealings in these key global commodities. More than 90 percent of the volume has already moved over to the computer screen. In the rest of the world, electronic trading for commodities has been the norm for years.

Although pockets of pit traders remain in certain commodities, the writing is on the wall. The computer is eliminating the pit trader.

Why? Pure economics: It's cheaper. No need for traders to leave their homes. No need to maintain a downtown facility with the associated high rents and utilities. No need to hire runners, phone clerks and trading clerks. And above all, no need for the pit trader.

I used to pay a good pit trader an extra $2 to $5 per contract half turn to execute my trades, and I was glad to do so. If the guy (just about all were men) was louder, bigger or quicker than my competitor's broker, I often would get the better price.

The cost savings of computer trading is obvious, but there's another advantage. Now it's a level playing field.

Ernest Hemingway once said, “The best way to find out if you can trust somebody is to trust them.” In the old days, you really had to trust your pit broker.

Let me share a true story with you. Years ago, I was using a silver broker in New York to execute my trades. All was going well until one day I placed an order to buy 50 silver contracts at a price that should have been filled easily.

After some time had elapsed, the silver market surged higher, netting me a tidy profit. Or at least that's what I believed.

I had been waiting for the pit broker's phone clerk to telephone me back with my fill. He hadn't yet, and when I called the floor, the broker denied that I'd ever placed the order. To this day, I have no doubt he pocketed my profit for himself.

The transaction wasn't recorded back then, so my only recourse was to never use this guy again. Subsequently, I did find a pit broker I could trust (one I used for many years until just recently). This is the kind of problem that doesn't occur with electronic trading; the computer doesn't lie.

Other than the cost savings of people elimination, there are additional benefits to electronic trading. Placing orders is as fast as a mouse click.

In the old days, in a fast-moving market, by the time the runner delivered our order to our pit broker, it was entirely possible to miss our price. Even with a market order (required to be filled at the next available price) during a wild pit session, we might not have known for hours what price we were filled out. And a good price was the luck of the draw at times.

Today these doubts are gone; fills return to the trader instantaneously. Plus, the computer can manage multiple orders and price fills more efficiently than a human. Clearing firms also like computerized trading because credit and risk management is automated. The computer can cut off an out-of-control trader before his or her account ever gets into an unsecured debit position.

Reduced cost, speed, enhanced information management, the expansion of markets globally 24 hours: Isn't technology terrific? Other than the loss of a few jobs and the romanticism of the bygone era of the pits, are there any downsides?

The legendary trader Jesse Livermore once said something to the effect that technology may change, but the markets never do because markets are still made by humans, and human nature doesn't change. The same mistakes made by traders 50 or 100 years ago are still made by traders every day.

This is true. Markets will continue to trend up and trend down.

I've long subscribed to Livermore's belief that markets have never--and will never--change. In many ways, this is true. But in a major way, it isn't now.

Eliminating people from the middle of the equation has made a difference. Electronic trading has changed the markets. As a trader, I've had to adjust to new market realities. And if you're trading commodities, you need to adjust as well.

What are the consequences of eliminating people? The answer, in one word, is volatility. And as a result, new trading skills are required for success. Speed and volume have teamed up and made the markets more volatile.

Volatility can lead to trader anxiety. However, an anxious trader isn't a successful trader. To succeed in trading today requires the ability to cope with exploding volatility.

Good luck, and good trading.

 

By George Kleinman
President
Commodity Resource Corp.
Lake Tahoe,
Nevada 89452-8700
http://www.commodity.com

George Kleinman is the President of the successful futures advisory and trading firm Commodity Resource Corp. (CRC). George founded CRC in 1983 while on the "floor" of the Minneapolis Grain Exchange to offer a more personalized level of service to traders. George has been an Exchange member for over 25 years. George entered the business with Merrill Lynch Commodities (1978 - 1983). At Merrill he attained the honor of 'Golden Circle' ­ one of Merrill's top ten commodity brokers internationally. He is a graduate of The Ohio State University with an MBA from Hofstra University. George has developed his own proprietary trading techniques and is the author of three books on commodity futures trading published by the Financial Times.

He is Executive Editor of Futures Market Forecaster, a KCI Financial publication. In 1995, George relocated CRC to Nevada and today trades from an office overlooking beautiful Lake Tahoe. The firm assists individuals and corporate clients. CRC¹s exclusive clearing firm is R.J. O'Brien with all client funds held at RJO (assets in excess of $1.9 billion). Founded in 1914, R.J. O'Brien is a privately owned Futures Commission Merchant, and one of the most respected independent futures brokerage firms in the industry. RJO is a founding member of the Chicago Mercantile Exchange, a full clearing member of the Chicago Board of Trade, New York Mercantile Exchange, Commodity Exchange of New York and the New York Board of Trade. RJO offers the latest in order entry technology coupled with 24-hour execution and clearing on every major futures exchange worldwide. There is risk of loss when trading commodity futures and this asset class is not appropriate for all investors.

Risk Disclaimer

Futures and futures options can entail a high degree of risk and are not appropriate for all investors. Commodities Trends is strictly the opinion of its writer. Use it as a valuable tool, not the "Holy Grail." Any actions taken by readers are for their own account and risk. Information is obtained from sources believed reliable, but is in no way guaranteed. The author may have positions in the markets mentioned including at times positions contrary to the advice quoted herein. Opinions, market data and recommendations are subject to change at any time. Past Results Are Not Necessarily Indicative of Future Results.

Hypothetical Performance

Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results.

George Kleinman Archive

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