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Electronic trading

Trading process has evolved over time. An individual or an institution needs to trade through a broker who is a member of the exchange. Couple of decades ago, here is how the trading workflow looked. The client would physically go to the broker’s office, or call the broker to know the estimate price of a financial security. The broker would get its representative in the stock exchange to inquire and / or execute the trade in on the exchange’s trading floor.

The trading order / message from the client to the broker and from the broker to the exchange was transmitted physically earlier on, and telephonically over time. The exchange was matching orders through open outcry markets shown in an image below

In 1990s and 2000, exchanges matching process became electronic without needing too much human intervention and soon the flow from the brokers to the exchange also became electronic. This was termed as electronic trading which rose dramatically in the last decade of 2000. It was also termed as Direct Market Access where client could see the price of a financial security on its computer screen and send an order to the stock exchange through a broker as shown in the image below

The end investors gets all the live market prices of various financial securities along with value added services (historical prices, analytics, charting, and some other information) on their screens on a computer (through an application or web) or tablet or mobile. The broker distributes this data to clients, manages their orders and executions while maintaining risk limit checks (i.e. a client is allowed to trade up to a certain amount as allowed by the broker based on the cash and assets deposited by the client with the broker) The exchange allows multiple brokers (and their end customers) to connect and trade on the exchange platform. The exchange distributes market data including the current orders in the market (called order book as a combination of various bids and offers) with all brokers (and their end customers) so they can make their trading decision, and matches all the orders based on conditions specified on the order, and manages regulatory compliance.

Benefits of electronic trading include:

– lower cost as less humans are involved and technology is almost always more economic

– more scalability (as technology helps in distribution easily)

– operational efficiencies with the use of the technology

– less room for errors (which may be introduced when humans interact)

Electronic trading has risen exponentially with the spread of internet and computers, leading to surge in the trading volumes across the world. Electronic trading has also been the foundation of other more sophisticated trading mechanisms including algorithmic trading, high frequency trading, dark pools, etc.

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