Under a pit trading system, when an investor places an order, the broker phones the firm’s trading desk on the exchange floor and relays the order to the firm’s floor broker. The floor broker goes to the pit in which the contract trades. The pit is an octagonal- or polygonal-shaped ring with steps descending to the center. Hand signals and a considerable amount of verbal activity are used to place bids and make offers. This process is called open outcry. When the order is filled, the information is relayed back, ultimately to the broker’s office, whereupon the broker telephones, faxes, or e-mails the customer to confirm the trade.
The process of placing and executing an order through the open-outcry system is a 140-year-old tradition that is slowly becoming outdated. Earlier, most derivatives exchanges outside the U.S. are fully automated so that bids and offers are submitted through a computer and trades are executed off the floor. Some systems even match buyer and seller. Automated systems are gradually gaining favor but pit trading unlikely to die for many more years.
Types of Orders
The several types of orders that investors can place with their brokers are as follows:
- Market Order: Market order, wherein the broker is instructed to buy or sell a stated number of shares immediately.
- Limit Order: Limit order, wherein a limit price is specified by the investor when the order is placed with the broker.
- Stop Order: For a stop order, the investor must specify a stop price. If it is a sell order, the stop price must be below the market price when the order is placed.
- Stop Limit Order: The stop-limit order helps investors know with more certainty the execution price associated with a stop order. With a stop-limit order, the investor specifies not one but two prices – a stop price and a limit price.