How Futures exchanges Work

Posted on June 1, 2007
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The majority of future contracts are traded on one of the 11 futures exchanges that are located in the US, London, Winnipeg, and others that are located throughout the world. Since these contracts can only be traded on the market that issued them there is no over the counter market. This means that if an investor buys a contract on one exchange, that all transactions concerning that exchange need to be handled during that exchanges hours, and at that exchanges prices.

Every order that is sent to the exchange if filled by a open outcry. What this means is that every order to buy or sell must be called out publicly, in a process that is similar to a auction, but it is called a price discovery. This simply means that those who scream the loudest make the most deals.

Most traders will charge their clients a hefty commission to execute their orders. Unlike the commissions that are charged on stock transactions, one for buying and another for selling, futures brokers only have one commission that they charge, to open and close a position. However, commissions are higher though, more often than not they are 18% or more of the cost of the transaction, opposed to the 2% or less that is charged for stock transactions.

For the first time in history the futures exchanges are facing competition from brokerage firms that have created derivatives for their clients. The idea behind this is that futures can be custom designed and timed to fit the specific needs of their clients, so that they aren’t at the mercy of the pit traders.

The Commodities Futures Trading Commission is responsible for monitoring the activities of the various exchanges. They do what the Securities Exchange Commission dose for stock trading. However there are some legitimate trading rules that seem to permit conflicts of interest, that are not allowed in stock trading. For example it is legal for a trader to be trading for himself and his clients at the same time, this is a practise that is known as dual trading and it has been singled out as being less than fair. With this practise a clients trades can be executed at a less advantageous price when the traders self interests take precedence.

Although on the plus side, these exchanges have standardized rules, accurate price records, and trading limits that prevent excessive price fluctuations.

How Futures exchanges Work

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