What is an Open Outcry?
The open outcry system for trading futures contracts is nothing more than a verbal auction between buyers and sellers of a commodity. Using the open outcry system for placing buys and sells, the buyer will "cry" out their best offer price and the seller will cry out their best offer price. When a buyer and seller both cry out the same price, a futures contract is made.
Open outcry may seem a bit unsophisticated but it is actually a very methodical process and can offer quite a bit of insight into the psyche of the traders in the trading pits. The system requires that traders cannot bid below the highest bid, nor can sellers offer higher than the best offer. This keeps the markets very efficient and keeps the bid and ask spreads very tight.
Advantages/Disadvantages of Open Outcry and Electronic Systems
Open outcry allows for floor traders to understand the emotions of the other traders on the floor when orders are being called in. This intangible information is essential for many of the traders on the floor. Being able to see a traders greed or fear offers much more than watching a chart on your computer. Many traders will key off of the "noise" in the pits to determine the volatility in the markets at a specific price point. There are a few services on the web that offer this live feed from the pits.
One key drawback to the open outcry system or any floor based trading system is that traders are not privy to the limit order book which will give the trader an insight into the depth of the market place. This is especially useful during periods of low volatility when pit noise is not useful.
In conclusion, it can be said that there are benefits and drawbacks of both electronic trading and the open outcry system used in the pits. The key difference between the two lies in the type of information that is available to both types of traders. Pit traders using open outcry or hand signals have more access to strategic information while electronic traders have more data to look at, such as time and sales and level II.