Electronic Trading Brings Alternatives To The Marketplace

It’s a small world – and getting smaller everyday.

The validity of that statement could be argued, but most will agree that with today’s technology, the world is a global marketplace where activities in Australia, Asia or Europe can have an immediate impact on activities in the U.S. This is especially true in the commodity markets where grain traders around the world are watching factors such as global supplies, weather and crop conditions. The introduction of side-by-side trading of grain commodities in August of 2006 shrank the marketplace even further.

So what does this mean to the producer in Dixon, N.D. or Fergus Falls, Minn., looking to manage their price risk? For some, it changes relatively nothing. For others, the changes could be significant.

Electronic Trading Speeds Information Flow
Agricultural commodities have traded electronically at the Minneapolis Grain Exchange (MGEX or Exchange) since 2002 when the Exchange first introduced its National Corn Index and National Soybean Index contracts. In August of 2006, agricultural grain commodities began trading side-by-side (electronically and via open outcry) during daytime trading hours. This change has created opportunities and challenges.

Organized chaos has often been used to describe open outcry trading. When the opening bell rings, mayhem erupts. At least that’s what it looks like to the outside observer. The traders on the floor know exactly what’s happening. They know who wants to buy and who wants to sell and at what price.

In the electronic market, it could be described as logical transparency. In short, the screen shows the bids and offers that are available in the market. It instantly shows the depth of market and market moves to anyone with access to an electronic trading system. The speed of information transfer and potential trade execution is significantly above that in the pit. According to Brian Rydlund, market analyst for Country Hedging in Inver Grove Heights, Minn., that doesn’t necessarily translate into better fills for the customer, but it does enable Country Hedging brokers to execute trades quicker and focus more time on market strategy rather than execution.

“We trade on both platforms – pit and electronic,” he says. “The key difference is that an execution in the pit may take 10 to 20 minutes to complete and communicate back to the customer. When I execute on the screen, it’s possible to do the trade while they are on the phone and provide them with their fill confirmation within seconds. It doesn’t mean it will be a better fill than the open outcry or pit trade, but the information flow is much quicker.”

Rydlund adds that the information he can see in the electronic market with regard to bids and offers in the system allows him to better prepare his customers for what to expect.

Dan Brophy, an independent trader from Chicago with cash grain and export background experience, says the key advantage to him is the visibility he gets into the whole market via the electronic platform. “With electronic trading, we have in essence leveled the playing field,” he said. “A producer in North Dakota, Brazil or France has access to the same information – at the same time – as a trader from a large trading firm or investment bank. They all see the same thing.”

Open Outcry vs. Electronic
It’s not about one versus the other with regard to the platforms, said Rydlund. Each has its own benefits and disadvantages. Rather, it’s about providing the customer a choice to their preferred method of execution.

“When side-by-side trading first came out, we had customers that didn’t understand that both platforms were trading the same contract,” said Rydlund. “The understanding is better now and our customers know the contracts are fungible, meaning we can buy or sell on either platform to balance our overall position. We give customers the choice of which platform they want to use. Some have a preference and others say to use what we think is best.”

For the market savvy producer or elevator operator, the electronic market creates an opportunity for them to execute their own trades. Rydlund said some of his clients want this capability and others prefer to have them do the execution. “Not everyone is set up or willing to execute their own future trades,’ he said. “They may be concerned with entering a number wrong or making an error. Buying or selling 500 contracts rather than the 50 you wanted is a big difference and some customers may not want that responsibility.”

The grain commodities have been making a steady migration to the electronic platform. Roughly 85 percent of the wheat contracts traded in Chicago is executed electronically. In Kansas City and Minneapolis, the percentage is roughly 40 to 45 percent.

The marketplace is evolving and new technology has created additional opportunities for market participants. For producers, education is a key factor. They need to develop a solid relationship with their broker, futures commission merchant (FCM) or clearing firm to ensure they understand the risks involved in trading futures and options – whether they trade them electronically or via open outcry.

The need for risk management in today’s volatile market is great and better information should enable producers and brokers to make more informed decisions.