What Are Floor Traders And What Did They Do?

Floor Traders

Today the market is entirely electronic.

You generate digital order tickets and route them to an electronic exchange that automatically matches your orders with corresponding orders, or else it sits on the digital order book waiting for another trader to route an order that satisfies it.

Outside of some hiccups created by high-frequency traders, it’s all so elegant and efficient.

But, what about the time before everyone had computers? What was it like before?

There were floor traders.

These were members of a physical securities exchange who took orders from customers over the phone, with the obligation to either trade against the order or find another trader in the pit who would take the other side of the trade.

To many younger traders like myself, it’s perplexing to see these guys pushing each other around in a big hall, screaming “buy, sell!” with no apparent rhyme or reason behind it all.

Older trading books like Market Wizards are packed with interviews with very successful floor traders explaining the time-tested trading principles that brought them immense riches.

Cut your losses quickly, size your bets effectively, the trend is your friend were all mantras of these traders, but how were they generating trading signals?

What about technical, fundamental, or quantitative analysis? How did these traders make profits simply by standing in a pit and trading verbally with minimal analytics at their grasp?

Floor Trading Edges

Still, the question remains: how did floor traders generate a trading edge?

Today, electronic traders might use technical patterns, fundamental factors, sentiment analysis, or elaborate statistical arbitrage tactics to find trading edges and use them for trading.

For the most part, Floor traders didn’t have much in the way of analytics or computing power, so was it just gut instinct? Partly.

The primary way floor traders generated an edge was through market-making.

For the most part, they bought on the bid and sold on the ask, collecting the spread. They did this many times, all day while managing their inventory to ensure they don’t get too long or short on one side of the market.

They instantly profited on almost every trade by virtue of earning the bid/ask spread. Do this enough times, and it doesn’t really matter how you’re generating trading signals so long as you’re managing risk.

William Eckhardt, known for his famous bet with Richard Dennis, which resulted in the Turtle Traders, had this to say about floor trading edges:

Off-the-floor traders live or die by their ideas about the market or their systems. That’s not true of floor traders. As a pit trader, you only need to be able to gauge when a market is out of line by a tick or a few ticks. Once you master that skill, you tend to survive, whether your underlying theory is sound or not. In fact, I know a lot of pit traders who subscribe to various bogus systems: moving averages, lunar cycles, and god only knows what. When they get signals from these systems, they essentially buy on the bid or sell on the offer. At the end of the month, they have a profit, which they always attribute to their system.

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