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Commodity Futures Trading

Commodity Futures Trading
June 06
21:14 2011

commodity futures

When observing the action on a commodities trading floor, such as the Chicago Mercantile Exchange or the Chicago Board of Trade, one gets the impression that the crowds of people shouting and gesticulating have all gone crazy.

Nothing could be further from the truth. In reality, the activity is quite organized, and rightly so since billions of dollars in futures contracts change hands on a daily basis.

The Open Outcry System

The basis of the organized madness witnessed on a commodity exchange consists of the “open outcry” trading process. Since its development in the 1800s, the open outcry system of trading commodities has been the basis for trading on commodity exchanges.

Nevertheless, as electronic trading has grown, the open outcry trading process is gradually fading into obscurity. European markets have all gone electronic with the exception of the London Metals Exchange, the last European exchange to continue trading with open outcry.

The open outcry system continues to be employed at the large Chicago exchanges, the Chicago Mercantile Exchange and the Chicago Board of Trade. It is also employed on U.S. stock and options exchanges.

The way traders use the open outcry system consists of yelling out their bids and offers in a “pit” which is designed with several tiers for traders to stand on while trading.

Pit traders also use hand signals constantly to ensure that no confusion over trades exist with other traders. Buyers will always bid with their hands facing themselves, while sellers face their hands outward.

After a trade is made, both the buyer and seller submit their tickets to the exchange, either through an exchange clerk or via a mechanical system. The trade is then time stamped and submitted to the Time and Sales department immediately in order to maintain an accurate record of the trade.

From there, the record of the trade is sent to the back office to be further processed and allocated to the proper trading account.

The Clearing Process

Once trades are consummated and reported to the exchange, the record of the trades on individual tickets is submitted to the Commodity Clearing Corporation. This organization is generally part of the exchange and processes all trades made on the floor.

In order to participate in trading on any commodity exchange, the brokerage or trader entering a trade must be a “clearing member”. This means that they will be able to participate in the trading of futures contracts on that exchange.

The clearing corporation initially takes the other side of all trades and guarantees each buy and sell ticket. After market hours, every trade is checked to ensure accuracy, with additional trade checks in the morning to clear any discrepancies before the beginning of the next trading day.

Despite the growing use of electronic trading systems, the open outcry method continues to be used and for good reason: a crowd of independent traders trading in a pit provides liquidity and depth to a market.

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