- 2000: Volume 9, No. 3 The Internet is Opening Up the World For Online Futures Traders

Albert Ehinger is no spring chicken. But at 73, after a long and successful career on Wall Street specializing in the U.S. Treasury market, he is not yet ready to retire gracefully. Instead, he actively trades E-Mini S&P 500 futures from home, using an online order entry system. For this exciting new lease on life, Ehinger and other individual traders like him, owe a big debt of gratitude to the Internet—and not a little to Europe, where the revolution in online futures trading really began.

Equity index futures, particularly the small-size contracts like the E-Mini S&P, are proving to be the launchpad for online futures trading in the United States, which has developed slowly in comparison to Europe, where the German-Swiss exchange Eurex set the early pace. The U.S. is now starting to catch up, however, as indicated by trading figures from the Chicago Mercantile Exchange, the center of these popular equity-related markets, where volume in the equity index sector rose a whopping 40 percent in the first four months of this year. That's a sure sign that online traders are swinging into action.

It's a good bet, too, that it won't be long before private traders in America like Ehinger are directing some of their desktop-driven trades to electronic exchanges in Frankfurt, London and other world centers of futures trading—in fact, a good many professionals already trade Frankfurt's DAX index contract. Although special conditions apply to the offer or sale of a foreign exchange-traded stock index futures contract in the U.S., the Commodity Futures Trading Commission recently gave consent (in the form of a no-action letter) for trading Eurex's Dow Jones STOXX 50 and EURO STOXX 50 index futures contracts, as well as two MSCI and three FTSE futures contracts traded on London's LIFFE exchange. The message is that the European exchanges are actively seeking online trading flow from America.

Internet Spurs Trading—and Knowledge

Until recently, the big futures exchanges in Chicago and New York, together with their member firms, were hampered by a stubborn adherence to "open outcry" trading and developers of online order entry systems found it difficult to synchronize their PC-based technology with old-fashioned floor trading and clearinghouse procedures. The emergence of the Internet altered all that, as daytrading in stocks demonstrated emphatically to Americans that markets (and why not futures markets?) could be traded seamlessly and securely from remote desktops, and not just by professionals at major institutions. The exchanges have responded—albeit ambivalently in view of the large "open outcry" lobby—because their leaders know that the emergence of online trading and electronic exchanges poses a significant, if not potentially fatal, competitive threat.

In spurring acceptance of online futures trading, the Internet has gone much further than providing a simplified technological solution. It has also been the medium through which individuals, especially newcomers, are discovering information about online trading—as well as a million other things. Traders could never do this before, but now the entire world has opened up to them and, armed with new-found knowledge, they are helping to force the issue and speed change.

The INO Forum, a message board that attracts hundreds of individual futures and options traders every day—and also a good many brokers—for discussions about the markets, and techniques and tools for traders. The brokers on the Forum are usually very experienced and extremely attuned to the opportunities and risks of online trading.

Gunter Kaiserauer, for example, a Manager with Freeman & Company, contributes to the INO Forum virtually every day. Always straightforward and to the point, he doesn't hesitate to warn new traders about the risks of trading online that they might otherwise overlook. "The new trader, lured by low online commissions and the seeming ease of online trading, often faces a brutal awakening," he writes on the Forum and adds, "Even experienced traders run into problems with online trading. In a panic situation, it is easy to send an order incorrectly. A 'buy' instead of a 'sell' can be a devastating error!"

Simulated Trading—Practice Makes Perfect

But if the Internet is inclined to push people into online trading too hastily, it is also helping, with equal force, to turn them into good traders. As an example, simulated trading lends itself to Internet applications and has become a very popular service offered by the futures industry, and there is no doubt that it has become an effective teaching aid for online traders. Stephen P. Auerbach, senior vice president of SunGard Futures Systems, comments: "Learning to trade online in a simulated environment is a great experience for a lot of people."

In February, SunGard Futures acquired the Auditrack simulator as well as the Auditrade order-entry system as part of its acquisition of U.S. Virtual, Inc., Boca Raton, FL, and is currently integrating these "front-end" applications with its back-office processing applications. In fact, Auerbach leaves no doubt that, as online trading expands into new markets and across boundaries, the order entry mechanism must be seamlessly connected to the clearing and settlement procedures. Keeping close track of customer accounts, including risk limits, is critical in markets where it now takes only seconds to get an order filled.

Kaiserauer notes that some brokerage firms control their risk by intercepting each online order and first checking the trader's account equity before passing along the order. This negates one of the main attractions of online trading, namely speed, and supports Auerbach's view that a truly effective system only comes from combining the order management process with back-office applications, what he calls "straight-through-processing."

When Every Second Counts

E-Mini S&P trader Ehinger, who uses LeoWeb, an order entry system developed by the LFG division of Refco, Inc., would not appreciate having his orders scrutinized on their way through to the CME. Anything more than six seconds for a fill and he'd feel that he wasn't in control of his destiny. Because he moves into action so fast, one particular feature of LeoWeb that Ehinger praises is the "Pending Page," a special screen where he can pre-enter a variety of buy and sell orders before trading starts. Then after the opening bell, when he decides its time to enter an order, all it takes is a single click of the mouse. For Ehinger, for whom "slippage" is something to avoid at all costs and whose trading watchword is "limit your losses," seconds clearly count for a lot.

But Ehinger is not a newcomer, as are many people who have discovered the apparent ease of trading futures via the Internet. Some of them barely know the basics of futures trading, as a story related by Kaiserauer demonstrates only too vividly. A new online trader recently called his broker who had set him up with an online account, and asked why his pork belly contract hadn't changed price in more than an hour. The broker replied: "It's locked up the limit," to which the trader responded, "What's a limit?"

Kaiserauer regularly admonishes new traders visiting the INO Forum to be as careful as they can using online order entry. "Remember," he wrote recently, "you are on your own, you don't have the broker anymore as a buffer between you and the market." He then listed six of the most common mistakes online traders make, as follows:

1. Writing "buy" instead of "sell" or "sell" instead of "buy."
2. Typing in the wrong symbol.
3. Forgetting to cancel stop-loss orders.
4. Transmitting an order before double-checking for accuracy.
5. Miscalculating the number of contracts bought or sold.
6. Trading too frequently.

The good news is that Kaiserauer's regular advisories, and the advice and counsel of many other experienced traders and brokers, are available on the Internet, and over time newcomers to futures trading will benefit in increasing numbers from this vital new information source. And if new futures traders find themselves fumbling, it's important to realize that online trading is still in its infancy, particularly when seen from the perspective of 150 years of "open outcry" futures trading, starting with the Chicago grain markets.

The developments now being undertaken by entrepreneurs like SunGard's Auerbach, tested daily by trader veterans as experienced as Ehinger, and supported by technological advances by the exchanges and the clearinghouses, will put progress made so far well into the shade. Five years ago, when we started INO.com on a wing and a prayer, little did we think that the Internet would bring futures trading into the living room—at least not so quickly. And very soon, from the comfort of his home, the online trader will be taking quick trips to London and Frankfurt, to Hong Kong and Sydney. As the world gets smaller, the trading opportunities will only get larger. We have the Internet to thank for that.

Alex McCallum is the editorial director of INO.com and moderator of the INO Forum. He was formerly U.S. financial editor at Reuters and director of communications at the Chicago Mercantile Exchange. The INO Forum is at http://forum.ino.com