The term pit refers to a physical arena at a stock exchange that is reserved for securities trading. Brokers buy and sell different securities in the pit, also called the trading floor, using the open outcry system. Traders match the orders of their customers by shouting and through hand signals. Orders are displayed, allowing everyone to participate and compete for the best price. Brokers and dealers trade their clients' orders and place proprietary trades for their own firms.
The majority of physical trading floors have been replaced by electronic trading platforms but there are a few that still exist, including at the New York Stock Exchange (NYSE).
Understanding the Pit
When most people think of stock exchanges, they often think of the fast-paced, chaotic environments characterized by colorful traders trying to outdo each other by shouting orders. If this is how you picture the pit, you're not mistaken. These are bustling and noisy spaces that are filled with traders who wear different colored jackets and badges that represent their brokerages. Pits are also called trading floors or trading pits.
The majority of activity takes place at the beginning and end of the trading day.
Clerks take orders by phone or computer from customers in the pit, and runners transmit orders between clerks and brokers.
Brokers and dealers may represent themselves. Alternatively, they may work for firms and trade for clients or the proprietary accounts of their firms. Specialists work their own books in the pit, making a market in securities and keeping a ledger of orders awaiting execution.
Since all orders are displayed, everyone has a chance to participate in trading activity.
There are very few physical trading floors that actually exist today. The NYSE and the Chicago Mercantile Exchange (CME) Group are two of the major exchanges that still have pits. That's because the trend has been to move away from the open outcry system and toward electronic trading. Since the late 1980s and early 1990s, many of the world's large exchanges have made the transition.
Traders may shout, wave their arms, and use special signals with their hands to communicate their trading intentions on the floor.
Hand signals facilitate quick trading and make it possible to be heard above the crowd. For instance, when a trader puts their palms toward their head, it indicates a buy order. If they want to indicate a sell order, they face their palms away from their head.
Some exchanges use different signals, though. For instance, a trader on the floor of the Chicago Board of Trade (CBOT) indicates the month of January by using their fist to mimic jamming something into their head. But someone working for the CME Group holds their throat between their thumb and index finger to denote the same month.
The Pit vs. Electronic Trading
Pit trading is not as common as it was in the past. There are very few physical arenas where trading is executed today. Although there is still some appeal to the open outcry system, electronic trading is much cheaper to run. Cutting out the middleman means a drop in fees and commissions for traders and investors and traders (and their firms) can expect a higher degree of productivity.
The majority of stock exchanges now operate through electronic trading platforms, which were first introduced in the 1980s. Exchanges like the NYSE and the CME Group kept their trading floor but began cutting brokers from the floor in 1984 after adopting an updated system that operated by phone.
The 1990s saw more automated systems rush in with the rise of internet technology. This period saw more powerful computers, higher trading volumes, and a drop in trading commissions. The 2000s saw the rise of algorithmic trading and faster technology.
With this boost in technology, traders and firms are able to benefit from a higher volume of trades during the trading day.