What it means
Picture a trading floor in a film, with crowds of people in coloured jackets shouting and waving their hands. The area where this happens is the pit, and each pit usually deals in one product, such as corn, crude oil or stock index futures.
Different steps of the pit are often used for different delivery months. Traders in the pit use open outcry, which means they announce their bids and offers aloud and signal them with their hands.
Palms facing inwards mean buy, while palms facing outwards mean sell, and fingers show the quantity or price. A deal is made when two traders agree, and it is recorded on a trading card and then entered into the exchange system.
Pits had advantages in their time. Prices were discovered in a visible, public way, and traders could sense the mood of the market from the noise and body language.
The system was also fast for the technology available and allowed complex deals to be arranged face to face. The weaknesses were cost, errors and limited access.
Only people on the floor could trade, mistakes could occur when orders were misheard, and the fees to run a floor were high. As computers became faster and cheaper, electronic platforms offered lower costs, wider access and a full record of every trade.
Today the great majority of futures trading takes place electronically, and many famous pits have closed or are used only for limited products. Some floors remain for particular options markets, partly for tradition and partly because certain complex orders are still easier to arrange in person.
The word pit also survives in everyday speech, for example in the phrase wheat pit or a pit trader. For business readers, the pit is useful as background.
Older books and financial news refer to pit traders, and the shift from the pit to the screen is a clear example of how technology changes markets. It also helps explain terms such as open outcry, floor broker and local.
In practice
Real-world examples.
Example
A grain merchant in the 1980s phones a floor broker to sell 50 contracts of wheat futures. The broker walks into the wheat pit and shouts the offer, and another trader agrees. The merchant receives a confirmation within minutes by telephone, and the written record follows later that day.
Example
A finance student visits a historic exchange and watches a demonstration of the former corn pit. The guide explains how traders used hand signals to show buy and sell interest in a noisy room where voices alone could not be heard. The student sees why electronic screens replaced the system, and also why some veterans miss the atmosphere.
Example
A risk manager at a food company reads an old trade report that mentions the pit. She notes that the numbers came from a manual record rather than a computer log, which makes some prices less precise. She adds a step to confirm the source of the data when comparing results across decades, so that the comparison is fair.
Case study
Seen in the real world.
Wexmoor Futures Exchange is a fictional exchange, and this case is illustrative. For decades, its busiest activity was a pit where around 400 traders dealt in grain contracts.
As electronic competitors arrived, the exchange found that screen trading cost far less per contract. A floor trade cost an average of $1.20 per contract to process, while an electronic trade cost $0.30, a saving of $0.90. On 10,000,000 contracts a year, the saving would be 10,000,000 x $0.90 = $9,000,000.
The exchange closed the grain pit in stages, kept a small floor for specialised options and moved most volume to its screen platform. Some traders left the industry, and others set up as electronic traders working from small offices. Customers noticed tighter gaps between buying and selling prices within a year. The illustrative lesson is that technology can make a long-standing practice obsolete when it cuts cost and widens access.
Watch out
Common mistakes.
- Thinking pits are still the main way futures are traded, when most volume is now electronic.
- Assuming the hand signals were informal, when they followed standard conventions that traders learned carefully.
- Treating a pit as a type of financial product rather than a place and method of trading.
Questions
People also ask.
What is open outcry?
It is a method of trading in which participants shout and signal their orders in person, and it is the opposite of matching orders by computer.
Where were the best known pits?
Chicago was the best known centre for futures pits, and large exchanges in New York, London and other financial cities also had floors with pits of their own.
Why did electronic trading replace the pit?
It was cheaper, faster, open to more participants and left a clear electronic record of every trade.
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