Pit trading and open outcry are soon to become a footnote in the free-market system.
In late October, the Minneapolis Grain Exchange (MGEX) released a statement: “After a long history of futures and options open outcry trading, MGEX is closing its trading pits effective Dec. 19, 2008.”
Side-by-side trading (electronic and open outcry in the pit) in grain futures began in August 2006. In Chicago corn futures, it took just five months for electronic trading to account for more than 50% of total volume — it was 87% in October 2008. (Similar figures apply to soybean futures.)
The shift to electronic trading of MGEX spring wheat futures occurred more slowly. In the first year, it never exceeded 30% of volume (see chart). However, growth was steady, crossing the 50% level in June and reaching nearly 80% of volume in October.?Unlike the Chicago corn pit, trading in Minneapolis spring wheat futures is not deep enough to sustain a pit when the majority of trading occurs in the electronic market.
Pit trading and open outcry provide a fast and efficient way to execute trades. As a former pit trader and one who loves the open outcry system, it pains me to admit that electronic trading is even faster and more efficient. Some people look at the demise of pit trading in Minneapolis as a dent in the armor of capitalism. On the contrary, the move to electronic trading is capitalism at its finest — the best system moves forward.
I spent eight years trading in the MGEX wheat pit. It is an exciting way to earn a living, but few aspects of the free-market system are more confusing and less understood.
First, what's with this loud, messy and confusing system of open outcry and hand signals? The purpose of open outcry is simple: Every trader — whether large or small, hedger or speculator — gets an equal opportunity to respond to every bid and offer. The pits are tiered to enhance equality by giving every trader a clear view of the action.
Trades in the pit occur on a first come, first serve basis, and it is the fairest system you can imagine. (Electronic trading stays true to this principle.) It is taboo to favor your buddy or ignore the jerk in the red jacket. Sometimes a newcomer to the pit does not appreciate the need to be fair, and trades a few contracts with the person next to him, ignoring the guy who was first to respond but 12 ft. away. Bad move. Every trader in the pit saw that small moment of injustice — this person is about to learn what it's like to be ignored by every trader in the pit.
Second, isn't futures trading just another form of legalized gambling?
There is an important distinction between speculation and gambling. Speculation involves risks that are real and inherent to the market — grain prices rise and fall in response to uncertainties in weather, demand, policy, etc. Futures trading allows the hedger, who wants to manage risk, to transfer it to the speculator, who voluntarily accepts risk for a chance to profit.
Gambling involves risks that are not real, but created for entertainment purposes. Whether it occurs in the pit or electronically, futures trading will survive because it serves an important economic purpose. 7
Ed Usset is a grain marketing specialist for the University of Minnesota Center for Farm Financial Management (CFFM). He can be reached at [email protected].