The buckets were straight up gambling houses with the action comprised of side bets on the actual stock movements, not unlike collateralized default swaps when purchased by someone who doesn't own the underlying debt.
See our Nov. 2011 post "Are Derivatives Contracts Nothing More than Unenforceable Gambling Debts?"
From the I-triple E ( Institute of Electrical and Electronics Engineers) History Center at Rutgers:
One day in August 1887 President Abner Wright of the Chicago Board of Trade forcibly removed the instruments of the Postal Telegraph Company and the Baltimore and Ohio Telegraph Company from the floor of the exchange, literally throwing their equipment out of the building.
A few months later, on the night of December 15, Wright discovered some mysterious electrical cables leading out of the basement of the exchange building. Thinking that they were telegraph lines, he cut them with an axe. Wright was neither deranged nor a Luddite. Instead, his forceful actions were dramatic examples of the troublesome technological, cultural, and economic relationship between the telegraph industry, finance capitalism, and organized gambling in the United States during the Gilded Age and Progressive Era.
Wright’s actions occurred in the context of a 25-year struggle between the Chicago Board of Trade and hundreds of bucket shops. Bucket shops, depending on whom one believed, were either gambling dens or small brokerage houses. Brokers and directors of the large exchanges claimed that bucket shops were nothing more than betting parlors in which patrons wagered on the price movements of stocks and commodities. Defenders of the bucket shops denied that they were gambling dens and asserted instead that they were independent brokers attempting to compete with the plutocrats and monopolists who controlled the New York and Chicago exchanges. In either case, bucket shops flourished between about 1880 and 1910. They purchased ticker service from the telegraph companies and depended upon the market quotations from the major exchanges to conduct their trades.
They charged lower commissions, required minimal margins, and traded in smaller lot sizes than brokers on the major exchanges. In this sense they democratized speculation: anyone with a few dollars could become part of the action on the Chicago and New York exchanges. However, customers’ trades were fictitious; bucket shops could not deliver actual stock certificates or grain to their patrons. Bucket shops were able to take root and to flourish in the late 19th and early 20th centuries for two major reasons, one technological and the other cultural. During the 1870s, two important innovations revolutionized the American telegraph industry. In the late 1860s Edward Calahan invented the ticker, a low-cost and low-maintenance printing telegraph which allowed brokers to monitor transactions on exchange floors.
Several inventors working for Western Union, including Thomas Edison, brought the ticker to a state of technical perfection by the mid-1870s. During the same period, Edison invented the quadruplex, a system which allowed four messages to travel simultaneously over one telegraph wire. The quadruplex gave Western Union a great deal of flexibility in handling its traffic.
On major trunk routes, it effectively quadrupled its circuit capacity without requiring the costly installation of more lines. More significantly from the standpoint of financial markets, the quadruplex allowed Western Union to lease excess circuit capacity to financiers and bucket shops. Taken together, the ticker and the quadruplex allowed Western Union to exploit the growing demand for realtime financial information. After about 1880 Western Union aggressively marketed its ticker service and private wire leases.
Within a few years, both brokers and bucket shops were leasing thousands of tickers and circuit miles to obtain real-time market quotations. Ticker service and wire leases soon became Western Union’s most lucrative activities. The company was reluctant to abandon this highly profitable market, and it did so halfheartedly around 1910 only under pressure from the major exchanges, courts of law, and antigambling reformers.
At the same time that Western Union earnestly began to exploit the demand for its ticker service, there existed widespread confusion about the difference between legitimate and economically useful speculation and illegitimate and harmful gambling. Farmers who blamed the Chicago Board of Trade for their economic woes, judges who protected the right of bucket shops to receive ticker service, economists who sought to explain how financial markets worked, and even brokers themselves all equated speculation with gambling. Many Americans saw little difference between the transactions on exchange floors and in bucket shops.
Bucket shops came to the notice of exchange officials in the late 1870s.
The leadership of the Chicago Board of Trade first recognized their growing threat in the summer of 1880, and they asked telegraph companies transmitting the Board’s market quotations to cease supplying ticker service to them. By 1890, anti-gambling reformers estimated that 5000 bucket shops existed throughout the country, including some 200 in New York, over 100 in Chicago, and at least one in each town with a population of 10,000. One reformer claimed in 1887 that bucket shops had so penetrated rural areas that they accounted for 90% of commodity trading in the countryside, and that they had depressed the price of agricultural commodities by a total of some $2.5 billion since 1880.
Stock brokers as well as commodity traders felt serious competition from bucket shops. One prominent broker on the New York Stock Exchange complained in 1889 that the “indiscriminate distribution of stock quotations to every liquor-saloon and other places has done much to interfere with business. Any person could step in a saloon and see the quotations.”
Indeed, by 1889 competition from bucket shops had depressed the value of a seat on the New York Stock Exchange by nearly half, from $34,000 to $18,000, and a seat on the Chicago Board of Trade by over two-thirds, from $2500 to $800. When they first opened for business in the late 1870s and early 1880s, bucket shops were small, independent store-front operations, typically located in the vice districts of large towns and cities.
Like the rest of the American economy in this period, bucket shops soon exhibited a trend toward consolidation and monopoly. As early as 1890 the New York Times reported that a syndicate popularly known as the “Big Four” controlled all the bucket shops in Manhattan, had offices in “every city of consequence in the Union,” and possessed capital amounting to “millions of dollars.”...MUCH MORE (8 page PDF)
Although the bucket shops rigged the game in their own favor to the point that if a "customer" kept coming back the mark would lose 100% of the amount wagered, there were some who understood the game, very few but enough that the operators kept an eye on the trades.*
Here's one of Haight & Freese' NYC shops. H&F were the largest of the stock operators with some 70 shops around the country.
"I began in the smaller bucket shops, where the man who traded in twenty shares at a clip was suspected of being John W. Gates in disguise or J. P. Morgan traveling incognito."By the time he was twenty-one his net worth had fallen to $2500.
"I kept my business to myself. It was a one-man business, anyhow. It was my head, wasn't it? Prices either were going the way I doped them out, without any help from friends or partners, or they were going the other way, and nobody could stop them out of kindness to me. I couldn't see where I needed to tell my business to anybody else. I've got friends, of course, but my business has always been the same - a one-man affair. That is why I have always played a lone hand."
Livermore's Fortune Reaches $10,000 - But There's Trouble
Livermore's success soon caused him problems. Bucket shop owners began to recognize him as a consistent winner - and they only wanted to trade against losers. He began having to take smaller positions than he wanted to, or even lose money in his first trades, only to later hit the bucket shop with "stings" where he took large winning positions.
As he became widely recognized, the shops began refusing to take his trades. They called him the Kid Plunger. (Plunger = reckless speculator.)
"I tried the other branches one after another, but they all got to know me, and my money wasn't any good in any of their offices. I couldn't even go in to look at the quotations without some of the clerks making cracks at me. I tried to get them to let me trade at long intervals by dividing my visits among them all. But that didn't work."
Despite the bucket shops refusing to deal with him (if they recognized him - Livermore took to disguising himself) or only trading with him under severe handicaps - such as Livermore paying higher prices for stocks he wanted to buy and getting less for stocks he wanted to sell than other customers - Livermore continued to trade profitably. By the age of 20 his fortune had grown to $10,000.
He had now reached a point where bucket shops began cheating on prices to prevent him winning. It was time, he realized, to move on and begin trading through legitimate stockbrokers....
So much for the "legitimate brokers".
Jon Markman's annotated edition hints strongly that Haight & Freese was one of the firms trying to get Livermore's business.
