Grain and Meat futures markets are broken. Transparency, integrity, and liquidity are at all time laws. Most legitimate 2 sided market makers are gone. The few who remain are being punished. Lease prices are approaching zero.
Most of the issues are caused by applying equity rules to commodity markets. And by building volume rather than liquidity because anyone who trades these products has seen that greater volume does not translate into greater liquidity.
Here are a few suggestions for how to fix these contracts.
Which one do you feel would help the most? What other ideas do you have?
- Use batch trades
This breaks the market up into a series of opens. Every 1 to 10 seconds depending on the Open Interest and Market Cap of that product. Turning the market into a series of time measured, exchange allocated executions would increase transparency, while preventing the need for circuit breakers and minimize the advantage of speed driven HFTs.
- Do not charge for passively executed trades
Without resting bids and offers, there can be no liquidity. If you enter and exit positions with aggressor orders then by definition, you are not a market maker. Passive orders are an essential part of any market and should be rewarded rather than punished. Liquidity has been decimated. Encourage risk takers by subsidizing their exchange fees from the aggressor.
- Less Trading Hours hours
Markets are open longer than necessary. This increases exposure and dilutes liquidity. There needs to be three sessions. One for each major time zone. Being open for less time with more frequent opens and closes will consolidate liquidity by concentrating market activity. Markets would then be closed when major reports are scheduled to be released, allowing short and long hedgers to digest this information.
- Use shading to indicate "paper” vs ”local” on the screen
Traders should be able to see whether activity is real or speculative. This can easily be accomplished by shading the bid and offer on the trading ladder. Customer orders would be shaded darker according to their percentage of the bid or offer pool.
- Trading rights should be for a specific product (rather than a specific exchange) and a specific person.
Market loyalty and integrity have eroded along with the value of a trading right because multiple traders are able to access every market for the price of a single trading right. This encourages predatory behavior because “destroying” one market is no longer harmful to profitability. Reducing spec limits would also help fight against the dilution of trading rights.
- Only show the best bid and offer.
Too much of the book is not real. There is no reason to distract from the best orders which are at risk and executable by showing a lot of bogus nonsense that is meant to deceive and misinform. Only show orders than can be traded against. This system worked for over a century before electronic trading.
- Hold market makers accountable.
If you are not a hedger, then you should be making markets, not taking them. Minimum ratios (contracts traded to contracts cancelled and market making to market taking trades) should be enforced for spec traders.
- Have Pro Active, Objective Market Regulation
Trading rules are too grey and their enforcement is too subjective. This can be alleviated by preventing violations before they occur. Rather than fining them once they’ve already been committed. Make it mandatory to write the basic, major restrictions into the trading software. This will prevent market harming behavior before it ever occurs. A few basic examples that should be written into the front end software is the inability to enter orders which if executed, would violate rules, including but not limited to self matching trades or trades that would violate spec limits. Another example of proactive regulation would be a Minimum quote life of 1 second. If an order was entered in good faith, as regulations demand, then It should not need to be immediately cancelled.
Batch trades and Minimum Quote Lives may seem like taking a step backward in the technological evolution of trading. Because they actually slow down the rate of execution. But such reasoning is specious and inaccurate. Just because trading used to be too slow does not mean that there is no such thing as too fast. If one remembers back to the days of open outcry where it could take several minutes from order entry to order confirmation, those frustrated customers needed quicker execution. They could not imagine trading could ever be too fast. But those same people were carrying around “brick phones”. And you could never have told them that there would be such thing as a cellular phone that was too small, either. But, here we are. The trend of smartphones has gone from making them as small as possible to making them as user friendly as possible. Today’s phones are larger than those of a few years ago.
Unfortunately, the exchanges have been slower when it comes to realizing that just because we have the ability to do something does not mean that implementing the technology is necessarily beneficial to the consumers. In futures trading, we have blazed past that threshold of speed utility and it’s time to recognize the need for a correction.