- 1999: Volume 8, No. 2 The Third Wave of Change

Futures traders frequently need to adjust their mindset as the market moves if they hope to survive. But how well they adapt to what might be characterized as a third wave of change in the futures and options industry in the next five years may be as important to their survival as any of their trading skills.

The first wave of change occurred in the mid-1970s when a series of events came together to catapult the futures industry from its butter-eggs-grains foundation into a new era featuring highly volatile traditional commodity markets, interest rate and currency futures based on a new "commodity" called money and a new product in equity options. From the massive Russian grain sales to an oil embargo to weather-inspired price runups to the new instruments to trade, it was a wild inflationary period that forever changed the way markets were viewed.

The second wave of change in the early 1980s introduced the cash-settlement concept, options on futures and futures and options contracts based on equity indexes and laid the foundation for launching a number of new international exchanges, especially in the financial area. Like the first wave, this wave included a highly inflationary period and other fundamental factors that changed perceptions about what could be traded.

The third wave of change traces its roots back to the 1980s and is more of an evolutionary development that is still taking shape. Technology is the driving force in this wave, as it is in many of our everyday activities, and the major impact in this case is not so much what market or instrument is traded but in how they are traded.

Technology Driven

As in the previous waves, unique events are helping to change traders' perceptions of a market in this third wave-stock markets that have climbed to unprecedented levels, a sharp setback to 1970s' prices for a number of commodities, economic turmoil in the Far East, Russia and Latin America, the introduction of the Euro and concerns about possible Year 2000 computer problems, to name a few.

But the key to this wave is the advance of technology, as the futures and options industry tries to incorporate the power of the personal computer and the internet into a trading system that is trying to become more efficient and less expensive to operate in a highly competitive marketplace. As traders tap into this power, they are eager to enter orders online and to see their trades executed directly and quickly in electronic trading systems that match buyer and seller without going through brokers and the traditional open-outcry process.

For some, the changes are coming too fast because they could eliminate jobs and livelihoods from the brokerage firm to the trading floors. For others, the changes can't come fast enough as they seek the most efficient system possible. For the moment, reality is somewhere in between.

Limitations of Technology

Despite the advances of the 1990s, technology is still too fragile and unreliable to support a complete conversion to electronic trading in the near future. Anyone who has gotten a "This program has performed an illegal operation" message or lost data or seen orders disappear into cyberspace because a system was down somewhere realizes significant improvements are still necessary on the technology side before the trading world will have enough confidence to jump into electronic trading with full force. For the time being, that leaves the open-outcry system as the most efficient for most futures and options markets, particularly where futures perform a crucial price-discovery function for the world.

While technology appears to have made more inroads in securities markets, the electronic trading process in futures markets is still in "the Pac man stage," according to one brokerage firm leader, or like "a stagecoach bouncing through rough terrain - and we don't even know what the terrain is yet," another industry official describes it.

In short, the futures and options industry is only in the very early stages of electronic trading. But, as technology continues to improve and as trading customers demand more efficient trading and support it with their commission dollars, the trend to electronic futures trading will continue to expand. That is already evident in the securities industry and at futures exchanges in Europe and elsewhere outside the United States.

Exchange Structure

Eventually, the futures industry could see some significant changes as membership-oriented exchange trading floors give way to large publicly-held electronic trading and clearing operations, brokerage firms become "service bureaus" rather than order processors and new firms are established that specialize in information/analysis/research.

Whatever happens and however quickly it happens, the most important role for traders of all types will be to adapt. Changes in trading are coming, and traders who adapt to the changes and position themselves for the future will find the potential opportunities unlimited. In the words of the trading maxim, "Trade with the trend."

Scott Slutsky and Darrell Jobman are the authors of Masters of the Futures, a recently released book from McGraw-Hill that features interviews with more than 20 of today's top futures and options industry officials on what they see ahead for the industry. Slutsky has been a floor trader at the Chicago Mercantile Exchange for more than 20 years and is president of Vantage Commodity Corp. Jobman was editor-in-chief of Futures magazine for more than 15 years and is editor of another McGraw-Hill book, The Handbook of Technical Analysis, published in 1995.