Even though more and more futures contracts are being traded online, there’s still plenty of action in the trading pits at Chicago Mercantile Exchange (CME) and other U.S. exchanges. That’s where traders determine futures prices, which change from minute to minute as trading goes on.
Is there only one pit?
No, there’s a pit for each commodity traded. CME has a lumber trading pit, a Eurodollar trading pit, an S&P 500 trading pit and so on.
What is trading?
In the futures industry, trading means buying and selling futures contracts. If you buy a futures contract at one price and sell it at a higher price, you make money. If you sell it at a lower price than what you paid for it, you lose money. Some people who trade futures are in it to make a profit by trading. Others are producers or users of commodities who are trading futures to protect a sale or purchase price.
The highest bid or lowest offer (the most competitive price) sets the true market value. A trader must “best” or beat that price in order to set a new “best” bid or offer. The seemingly frantic nature of the open outcry system is really about brokers and traders constantly bidding or offering prices that the market will perceive as the true value; and trades will then occur. This process is called “price discovery,” and it is based on the belief that in a free market system the optimum price will emerge as the result of the pressures of supply and demand.
What does this mean?
- Palm in means an offer to buy
- Hand away and in front of body means show price
- Hand touching or near face shows quantity. Touching forehead and hand sideways means buy 70 contracts.
In pit trading, hand signals, as well as vocal open outcry, relay quantity and price information between traders and brokers across the pit. As in any auction situation, a trader’s action or word is a bond. With billions of dollars at stake, each action in the pits is actually a carefully recorded and executed trade agreement. Though seemingly chaotic, what you are witnessing in a futures trading pit are market professionals conducting business at lightning speed for either customers or for personal profit. In markets where prices move rapidly within short periods of time, the speed of trade execution and timely delivery of orders to customers is essential, because every minute (or second) that goes by can mean a large difference in how much money is gained or lost in that trade.
Additional Lessons
- Futures Contract
- Futures Exchange
- Contracts Traded
- Supply and Demand
- Fundamental Analysis
- Technical Analysis
- Orders in the Pit
- Risk Management
- Hedges & Speculators
- Options on Futures
- Reading Quotes
- GLOBEX
- Hand Signals
- Expiration Months
Contents Courtesy of CME Group.