Today, nearly all trading is “electronic trading.” Switch on your computer. Login to your broker’s account. See what you want to buy or sell. Click your mouse, and you are in a trade. It seems easy, right?
Electronic trading has revolutionized the financial markets. It has created new opportunities to access the markets in ways that traders could not before.
However, we often take electronic trading for granted. The financial markets have existed for centuries, and electronic trading is relatively new. So, let’s stop for a second and discuss what “electronic trading” means, its pros and cons, and how to take advantage of it.
What Is Electronic Trading?
There are two parts to Electronic Trading:
- Retail traders (or individual investors) use computer technology and the internet to access market information and place trades directly on a platform.
- Brokers and exchanges connect electronically to fill orders.
Let’s explore each part.
Part 1: Electronic Trading for Individual Investors
Pre-1990s, before the personal computer revolution, individual traders would communicate with brokers through the telephone. For example, in the 1990s, when I bought shares in a UK company on the London Stock Exchange, I called my broker and asked to buy a hundred shares (the company was Manchester United—yes, that’s right, the English football team!). My broker at the other end of the phone told me the price and asked me to confirm the order verbally. He then confirmed that he had filled my trade. It only took about a minute, but it was a manual process.
I grew up in the UK, and the only markets I knew were UK stocks trading on the London Stock Exchange. So, that’s all I bought and sold. When I wanted to research companies, I bought a newspaper with a business section (The Sunday Times) and a weekly investor’s magazine (Investor’s Chronicle). I found companies that I thought would do well and bought their shares.
My story of trading in the 1990s in England is typical of how most people traded before electronic trading—buying newspapers or magazines for research and phoning brokers to place orders. When electronic trading arrived, I discovered an online trading software, Warden Brothers, with access to charts of US stocks. This electronic charting platform helped me develop my technical analysis skills and gave me access to analyzing a much broader range of stocks in the US. Emerging online brokers gave me access to purchasing US stocks and options. Electronic trading then introduced me to Forex in the early 2000s.
My trading journey highlights what electronic trading has done for the masses: opened new markets, information, instruments, and trading methods to a new population of traders. But primarily, it has levelled the playing field: everyone has access to equal information, markets, and low costs. For example, pre-2000, most banks, and brokers required individuals to have about a $500,000 account size to trade Forex. Now, almost anyone can open a Forex account for as little as a few hundred dollars.
Charts & Technical Analysis
Technical analysis existed long before electronic trading. One of the first books in the west on the subject, “Technical Analysis of Stock Trends” by Edwards & Magee, was first published in 1948. Ralph Nelson Elliott invented Elliott wave theory in the 1930s. Going further back, candlestick charts are thought to have been developed in the 18th century by Munehisa Homma, a Japanese rice trader.
People were analyzing charts using technical analysis long before electronic trading. They either constructed charts by hand using historical data or bought printed historical chart books. That’s important to note because it shows that the raw skillset matters as much as access to technology. My favourite example of raw trading skills without computers was from Nicolas Darvas, who made $2,000,000 in the stock market in the 1950s. He did not even have charts or access to news—his broker would send a telegram (which was like a text message before computers and cell phones!) of only the closing prices of stocks. From that information alone, he chose which stocks to buy and sell, and made millions of dollars in the process.
Electronic trading meant that traders could access:
- Lots of new markets. For example, international stocks, Forex, and now crypto
- Real-time data. Traders can see price changes move in real-time, allowing intraday trading.
- Many different timeframes. I can look for support and resistance on weekly charts and then zoom in on an intraday chart in a matter of seconds.
- The ease of adding indicators and adjusting settings. Some indicators can be calculated by hand, but as you add more and want to adjust settings, it will be nearly impossible to continue calculating it by hand.
- Automated trading from systems and signal providers. Today, retail traders can access automated trading systems and signal providers that place trades on clients’ accounts, usually for a fee. This means anyone can replicate a successful person’s trades. There are risks with this, of course—in particular, the person could stop being profitable. And following a signal provider means I will not learn how to trade; instead, I will be trading blindly. But it can be a way to create profits if I select someone with a good record and test with a small account first. Plus, I can follow multiple signal providers or systems to spread my risk.
Examples & Benefits of Electronic Trading
There are several good examples of electronic trading bringing benefits to traders. Let’s look at a few.
Brokers Offer Multiple Markets in One Account
Electronic trading has allowed brokers to offer clients access to hundreds of instruments in dozens of markets in a single account at low costs. Many brokers will let me trade can trade US stocks, UK stocks, crypto, Forex pairs, commodities such as gold or oil or all from one account!
Option Trading is Easier
Options contracts can be complex instruments: an option can be a call or a put option (the right to buy or sell an underlying security, respectively), and they have different “strike prices” and expiration dates. I can go long or short of an option contract, and I can combine different options contracts to produce different outcomes. I have traded options on US stocks, and I would not have been able to manage the complexity without electronic platforms displaying that data on a screen. Imagine someone on the phone reading out all the numbers—it would never work!
ECN Forex Brokers
Retail traders can directly access Forex liquidity providers through electronic communication networks (ECNs). The broker submits the order to the ECN, which fills it. The trader pays the broker a commission for access to the underlying ECN market. Because the client is getting “raw” prices and spreads from liquidity providers through the ECN, they do not have to worry that the broker is manipulating the charts to their advantage and at the client’s disadvantage. This is the most transparent way to trade Forex.
Electronic Trading Risks
- Technology and Internet Connection
Electronic trading relies on computer hardware and a stable internet connection. Over the years, computer hardware has become more powerful and cheaper, and more people have access to faster internet connections. However, any problems with your technology and connections can cut you off from your trading account. Certain brokers do not offer telephone service, so beware if unstable technology has been an issue for you in the past.
- Quality of Online Brokers
Not all brokers are reputable or honest with their clients. Especially in over-the-counter markets, such as Forex, without a central exchange, brokers can decide the pricing and give you poor fills if they are set up as counterparty to take the other side of your trade. Furthermore, certain brokers are in places with little regulatory oversight, putting client deposits at risk. In a few cases, brokers have vanished with clients’ money. Make sure to choose a broker that is regulated by a strong regulator. Some of the best regulatory bodies are in the US, UK, European Union, Australia, and Canada. Any broker regulated in one of these regions must operate under strict rules including segregating clients’ funds from their own operations.
- Security of Crypto Brokers and Exchanges
By their very nature, investors can only access crypto assets electronically. Because crypto is so new and unregulated compared to Futures and stocks, there have been issues with certain crypto exchanges and “electronic wallets” which have gone bankrupt or hacked, resulting in clients losing deposits.
- Access to Too Much Information
This risk is not easy to spot but can significantly affect a trader’s profitability. One of the positive consequences of starting my trading journey before electronic trading became the norm was that I focussed on just a few markets and a few types of charts patterns and timeframes. In my early years, I made six figures trading only two markets, the FTSE 100 index, and the GBP/USD currency pair, looking at only two timeframes. That level of small focus made me know each market and trade setup very well.
Electronic Trading vs. Floor Trading
Another significant shift towards electronic trading is that exchanges have moved from floor trading to pure computerized exchanges.
What Is floor trading?
Floor trading is when an exchange has a physical area, known as a trading pit, where floor traders provide liquidity and fill trades. Floor traders use a verbal and hand signal communication method called “open outcry.” Imagine a room full of people shouting and gesturing to each other in what looks like organized chaos—that’s floor trading.
Does floor trading still exist?
True floor trading using open outcry without computers no longer exists at any major exchange. One of the last exchanges to close their trading pits was the Chicago Mercantile Exchange in 2022.
What was the first computerized exchange?
It was the NASDAQ in 1971.
Why is electronic trading better than floor trading?
- Speed. Humans could never match the execution speed of computers.
- Efficiency and lower costs. Once computers proved more efficient, this resulted in lower spreads and commissions for investors placing trades.
- More direct access. The move to automate trading electronically also made sense because it allowed retail investors to conduct trades independently, thus eliminating the need for brokers, dealers, and other professionals to execute trades on their behalf.
Electronic Trading: Pros and Cons
- Access to a range of instruments and markets: e.g., Forex, stocks, commodities, and crypto.
- Speed of executing trades. For example, Forex brokers can execute most trades in a few milliseconds.
- Lowering costs: smaller spreads and lower commissions.
- Many available online brokers give retail traders extensive choices in regulations, account sizes, differing market access, and types of execution.
- Charting platforms with technical analysis tools and easy access to multiple timeframes.
- Real-time price data: especially useful for short-term trading.
- Record keeping. Online brokerage platforms keep accurate records of your trading history and performance.
- Reliance on stable computer hardware and internet connections. Technology is always getting more reliable, but this is a risk if your computer or internet connection goes down.
- Access to too much information causes distraction. This can cause “paralysis by analysis.” If I focus on too many markets or methods, my knowledge is spread thin, and I become less effective.
- Some unreputable online brokers. Not all markets or regions are well-regulated. Always look for brokers with segregated client accounts. Do not go for brokers only because they are cheap.
There is no better time to be a trader than today, because electronic trading has vastly improved the landscape for individual investors. Electronic trading provides access to hundreds of markets worldwide, lower costs, faster execution, and charting platforms for technical analysis.
There are very few disadvantages to electronic trading. Traders rely on stable internet connections and computer hardware. If either of these goes down, market access is cut off.
Remember, trading is a skill independent of technology, which is just a tool. Electronic trading cannot replace the practice, skill, and discipline every trader needs to be profitable.
What does an electronic trader do?
Electronic traders buy and sell securities, such as stocks or Forex, through electronic platforms connected to their brokers through the internet.
What is electronic trading also known as?
Electronic trading is also known as online trading.
Is electronic trading better than normal trading?
Yes, electronic trading is more efficient, less costly, and gives more opportunities.
What is the electronic stock market?
An electronic stock market is a computerized exchange for stocks. An example of this is the NASDAQ.
What is an example of electronic trading?
An example of electronic trading is a trader using a Forex broker connected to an electronic communications network (ECN) to fill their trade.