Post No: 31

Date: 14.05.2016

Topic: How we used to trade and how are we trading now?

The Technology has brought many facilities to the human mankind. In the earlier days the buying and selling of goods was used by barter system. Later on, the civilized society brought into the mechanism called “currency”.  But still there were many difficulties to buying and selling of goods.

What is a market?

It is a place where both buyers and sellers meet. But when a buyer wants to buy a particular goods or any article, the buyer needs to know the price offered by all the sellers. The buyer will have to look into the prices, so that he gets a best price in the market. Generally in the financial markets terminology, the buyer at which he is willing to buy is known as “bid” price. As a buyer, it is obvious that we will look into the lowest price in the market. On the same lines, the seller who wants to sell something will look for a better price to sell or the highest price for his goods.  Therefore, a buyer will look for a lowest price and a seller will look for a highest price. The selling price at which the seller is willing to sell is known as “offer” price in the financial markets.

What were the methods to buy and sell in olden days?

In the olden days, there used to be an “open outcry system”. This open outcry system can be seen even in today’s world, when we go out for buying vegetables in some parts of the world. The open outcry system for financial markets also resembles the same vegetable markets, but with certain modifications. To understand, how an open outcry system appears, we can look into the following diagram:

I have tried my best to draw a diagram, instead of copying and pasting from somewhere else. All the sellers will be standing in the well (not really a well of water) typed system. All the buyers will be watching those sellers around the pool / well. The buyers and sellers will be using “hand signals” / “special sign signals” or verbal ‘bid’ and ‘offer’ prices. One of the major disadvantages was the information in one market would not flow to other nearby markets.

What is the present way of buying and selling?

For the financial markets, now with the rapid and innovation of technology, for buying and selling of financial instruments, there are many exchanges. These exchanges enable both the buyers and sellers meet and give their quotes through electronic means. They provide us a platform, where we can view the various bid (buying) prices and also the offer prices (selling). These exchanges use “electronic algorithms” to enable trading (buying / selling) mechanism.

What are the risks in trading with exchange and without exchange?

Type of risks	In one to one or without exchange	Trading by using Exchange
Contract execution	No guarantee that the contract to buy or sell will be executed	It can be avoided
Price risk	There is no guarantee that we can buy at the agreed price (if we are buying in future through a forward contract)	It can be avoided
Legal risk	If we are having a positive MTM, the counterparty may can cancel the contract or may not honor the contract	It can be avoided
Operational risk	The counterparty may cancel the contract or may not stick to the prices or procedures or failure to honor the contract	It can be avoided
Similarly, the parties may not have trust on each other, it would invite many other risks like settlement risk, liquidity risk etc from both parties (buyer and seller)

For any doubts, contact at my personal mail id: cfa.surya@gmail.com