Electronic trading, sometimes called eTrading or e-Trading, is a method of trading trading securities (such as stocks, and bonds), foreign currency, and exchange traded derivatives electronically. It uses information technology to bring together buyers and sellers through electronic media to create a virtual market place. NASDAQ and Globex are examples of electronic market places.
Historically, stock markets were physical locations where buyers and sellers met and negotiated. With the improvement in communications technology, the need for a physical location is of diminishing importance as the buyers and sellers can electronically exchange indications of interests as well as negotiate from a remote location.
Electronic trading makes transactions easier to complete, monitor, clear, and settle. These are major drivers for most market regulators to insist that all markets eventually must be developed electronically.[citation needed]
NASDAQ, set up in 1971, was the world's first electronic stock market. It took 35 more years for the NYSE to automate its trading process but it is now clear that the days of exchange floor trading are coming to an end.[citation needed] By early 2007 organizations like the Chicago Mercantile Exchange were creating electronic trading platforms to support the emerging interest in trading within the Foreign exchange market.
Today many investment firms on both the buy and sell side are increasing their spending on technology for electronic trading. At the same time many floor traders and brokers are being removed from the trading process. Traders are relying on algorithms to analyze market conditions and then execute their orders. Dates of introduction of electronic trading by leading exchange in 120 countries is provided in a Journal of Finance article published in 2005 “Financial market design and the equity premium: Electronic vs. floor trading,”. Leading academic research in this field is conducted by Professor Ian Domowitz and Professor Pankaj Jain.[citation needed]
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 colored 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 GFI Group, 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.
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