Automated systems report market data to the public much faster and much more accurately than do floor-based trading systems.

In any event, automated trading systems can arrange trades much more quickly than can individual traders. In an oral auction, traders must manually record the price, the size, the counterparty and the item traded for each of their trades. In many markets, they must also record the time of the trade. Since trading requires both order entry and trade record keeping, traders can complete trades more quickly in electronic markets than in oral markets.

Oral trading, however, is undoubtedly faster than screen-based trading when traders want to negotiate their trade sizes. In such negotiations, traders often will not reveal the full size of their order unless they are sure that the other trader will trade the same size. Accordingly, after agreeing on a price, they often take turns proposing successively higher sizes. Negotiations stop when one trader proposes a greater size than the other trader will accept. The trade size is then the last agreed-upon size. This back and forth negotiation moves very quickly in oral auctions. When conducted through a computer that only accepts firm orders, the negotiation is much slower, since the traders must split their orders into pieces to avoid displaying their full sizes.

Some electronic trading systems, such as Reuters' Instinet, solve this order display problem by providing messaging systems that allow a buyer and seller to negotiate their trade size through the exchange of messages on their screens. Others allow large traders to place hidden limit orders to restrict the displayed size of orders.

Exchange of Information
Floor-based trading systems dominate electronic trading systems when brokers need to exchange information about buyers and sellers to arrange their trades. Most electronic trading systems do not provide this information.

Such information is especially important for large traders who want to avoid trading with well-informed traders. When a well-informed trader wants to sell, prices are probably too high. It is a poor time to be a buyer. It is always better to not trade than to trade at a poor price. Therefore, large traders often direct their brokers to trade only with institutions they deem to be uninformed. They prefer to trade with institutions that have no research staffs and that trade only to invest and disinvest rather than to speculate. They often refuse to trade with the proprietary trading groups of investment banks for fear of losing to them. Large traders can issue these instructions to their brokers because they can afford the significant commissions necessary to obtain the personal attention necessary to provide these services.

Traders also do not want to trade with a large trader if that trader intends to continue trading on the same side afterwards. The market impact of the large trader's subsequent trades will generate immediate losses for the first traders. Traders therefore instruct their brokers to ask how much more size the other side wants to do. On an exchange floor, a broker who has no additional size to fill will freely offer this information to obtain a better price. In an electronic trading system, no similar mechanism allows traders to credibly indicate to each other how much additional size remains in their orders.

Market Data Reporting
Automated systems report market data to the public much faster and much more accurately than do floor-based trading systems. In floor-based systems, traders or market reporters must manually enter quotes and trades into the market information system to report them to the public. In automated systems, the data is already in electronic form.

Cost
Fully automated trading systems have high initial creation costs. They require extensive data networks and data processing systems that validate users, accept orders, process orders, report trades and report order status. These functions must all be reliable, secure and fast. Several vendors sell fully automated trading systems off-the-shelf for about $5 million for purchase and set up. Once established, electronic trading systems have small operating costs because everything is automated.

Floor-based trading systems cost less to set up than electronic trading systems. To set up a floor-based trading system, an exchange needs to acquire and/or build a suitable trading floor. A floor-based market must also have adequate telecommunications systems to route orders in and market information out as well as various information display systems to assist their floor-based trade.

However, floor-based trading systems are often quite expensive to operate. They require substantial labor to run. Well-trained brokers must communicate with clients, and arrange trades. Reporters must report the trades. Officials must watch for trading abuses. And runners often must carry messages to and from brokers. The brokers must know and follow the trading rules and procedures, and they also must know how to best expose their orders and negotiate their trades.

In contrast, electronic trading systems do not require well-trained brokers to operate. In many such systems, brokerage clients can access the market themselves without the involvement of their brokers.

Conclusion and Predictions
Floor-based trading systems and automated trading systems have different strengths and weaknesses. Consequently, they appeal to different clienteles. It is unlikely that one market structure will dominate all trading.

Fully automated systems are fast and generally cheap to use and operate. These characteristics ensure that active markets and markets that serve small traders will use automated trading systems extensively. In the U.S. equities markets, Bernard L. Madoff Investment Securities and other dealers that offer automated execution systems provide excellent service to high volumes of small traders. Options markets tend to have high order volumes and small transaction sizes. These markets therefore will automate their trading.

Fully automated systems also allow traders to exercise direct control over their orders. They therefore appeal to traders who do not trust their brokers or to traders who do not want to pay for brokerage. Large institutions that are concerned about how brokers expose their orders often favor automated systems if they are willing to employ their own traders.

Floor systems work best when traders need to exchange information about each other before they trade. They also work best when brokers need to actively search for traders to fill their orders. Since these advantages are most important to large traders, floor-based markets will serve primarily large institutional traders. Increasingly, the NYSE is an institutional market. Although people have been predicting the demise of the NYSE floor since the mid-1960s, it will not disappear as long as the brokers there provide services that cannot be provided elsewhere.

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