Electronic Trading Systems

The electronic trading system involves the use of modern information technologies in business. Most large markets use electronic devices in their transactions to enhance efficiency and sufficiency. In such markets, traders and exchange systems are interdependent. While traders need fast order processing and communication systems, exchanges need electronic exchange systems to process the large number of orders traders place.

The global use of electronic trading systems reduces the trading costs for buy-side traders due to increased efficiencies from using automated systems.

Factors Driving the Development Electronic Trading System

The use of new technology in businesses has been adopted globally. The factors which have contributed to the adoption of this mode of trading include:

1. Cost: Electronic systems are relatively cheap to start and operate. They do not require exchange officials to record and report prices.
2. Precision: Electronic exchange systems execute the programmed command. Therefore, there are fewer errors compared to manual methods.
3. Order and timing of events: Electronic systems keep good audit trails of transactions for easy determination of the correct sequence and timing of activities.
4. Security and confidentiality: Trading with electronic systems guarantees clients’ privacy. The clients’ hidden orders are well kept.
5. Accessibility: The electronic order-matching system can be operated at any time of the day.
6. Convenience: The use of electronic systems enables trading to be done anywhere as long as the credentials for the transaction are available.
7. Effectiveness: Electronic systems cannot be affected by weather conditions because operations are made in the server rooms, unlike floor-based trading, which is affected by bad weather.

Reasons for the Domination of Computers in the Implementation of Trading Strategies

1. Broad attention span and scope: Users can respond to information from many trading instruments and make several transactions simultaneously.
2. Accelerated responses: Computers give quick answers. Due to this, there is little or no time wasted.
3. Precision: Computers execute what they are commanded to do.
4. Stores user information: Computers ensure that the information keyed in by a user is saved. There is no information lost unless there was an abrupt alteration of the system before the data was kept.

It is worth noting that the growth of electronic systems has led to low transaction costs because of increased efficiency. Besides, it has caused a decrease in the bid-ask spreads.

Furthermore, transaction costs decrease with large orders, since they are fragmented into smaller units for execution—the implementation shortfall for filling orders declines with the growth of electronic trading.

Question

Which of the following choices is most accurate about electronic trading systems?

1. The trading of corporate and municipal bonds has been more affected by the development of electronic markets than the trading of equities.
2. Electronic trading systems have caused wider spreads quoted for smaller sizes for bid-side traders due to competition.
3. Electronic trading systems are more efficient and incur low transaction costs relative to floor-based trading systems.

Solution

The correct answer is C.

The widespread use of electronic trading systems has significantly decreased trading costs for buy-side traders. Costs have declined since exchanges have obtained greater cost efficiencies from using electronic matching systems instead of floor-based manual trading systems. These technologies have also decreased costs and increased efficiency for dealers and arbitrageurs who provide much of the liquidity offered at exchanges.

A is incorrect. Electronic trading has not had as much of an impact on the markets for corporate and municipal bonds as it has on equity markets. The market structures of corporate and municipal bond markets have hardly changed since the 19th century. Although many creative developers have invested much effort in electronic bond trading systems, most public investors in these markets still trade with dealers largely over the counter.

B is incorrect. Competition has forced dealers to pass many of the benefits of their new technologies onto buy-side traders in the form of narrower spreads quoted for larger sizes.

Portfolio Construction: Learning Module 6: Trading Costs and Electronic Markets; Los 6(d): Describe factors driving the development of electronic trading systems