To stay away from another Flash Crash, new circuit breakers for the stock market were suggested by the Securities and Exchange Commission on Tuesday. The new trading curbs would be applied at first as a trial run to all stocks on the Standard and Poor’s Index. The SEC said the new stock market circuit breakers will pause trading in specific stocks if their prices move by 10 percent or more in five minutes. The trial will start after a 10-day comment period and will last through Dec. 10. The proposal is a response to the unexplained market slide May 6 that drove the Dow Jones industrial average down 700 points within just minutes.
Volatile stocks the focus of NYSE circuit breakers
NYSE circuit breakers already in place did not end up being set off during the May 6 Flash Crash, but those trading curbs are market-based — they do not apply at the individual stock level. Reuters reports that regulators and the exchanges have been under pressure to figure out what actually triggered the May 6 meltdown and do something to repair the integrity of U.S. stock markets. The exact cause of the Flash Crash has yet to be determined, but a mechanism to briefly halt trading across markets for a single stock has emerged as a solution. Reuters, a European news service, explains that the new NYSE circuit breakers are very similar to stricter methods used in European markets. Circuit breakers at the London Stock Exchange are depending only on the liquidity and volatility of the individual stocks.
Flash Crash exposes the stub quotes
The stock market Flash Crash on May 6 brought the market down nearly 1,000 points in a matter of hours. Traders could have looked for cheap payroll loans, and also the Dow soon rebounded, but it finished the day down 347.80, or 3.2 percent, at 10,520.32. According to the New York Times, some individual stocks suffered even more than the market at large. Five exchange traded funds which are mutual funds that trade like stock, were down to a penny or less per share. There were also nine a lot more trading at 15 cents or less per stock. Stocks traded hands for only a penny a share because of what the SEC calls “stub quotes,” or placeholder bids that traders will often enter into the electronic system when they don’t really want to purchase or sell a stock, but want to stay in the game.
A lot more equitable are the new NYSE circuit breakers
Thousands of trades in hundreds of stocks were canceled as a result of having been judged as “clearly erroneous,” executed by computer before traders were able to react to what was happening within the market. Market regulators actually canceled any trades that took place between 2:40 and 3 p.m. that were 60 percent or more below the last trade that took place before 2:40 pm. In the exact same exact article, Reuters says that some investors believe the circuit breaker on individual stocks is a more equitable approach to prevent drastic, across-the-board trade cancellations.
“The broad market circuit breakers affect everybody, and could penalize people for what could be an index move,” Lou Matrone, a sales trader at JonesTrading, told Reuters. “But the stock-based ones deal with it specifically on a case by case basis. You’re not penalizing people for trading stocks where nothing is really going on, they’re not being dragged in for a ‘fat finger’ problem or some other problem.”
SEC considers other trading curbs
During the six-month circuit breaker trial period, the New York Times reports that the SEC may also consider other trading curbs that ended up being discussed during a recent Congressional inquiry to the May 6 disaster. Incorporated were methods to address the risks of market orders, a possible ban on so-called stub quotes of one or a few cents for a stock that is trading substantially higher than that, and also the use of trading pauses at various exchanges.
Additional info at these websites
10-day comment period
http://sec.gov/news/press/2010/2010-80.htm
Reuters reports
http://www.reuters.com/article/idUSN1817385520100518
New York Times
http://www.nytimes.com/2010/05/19/business/19crash.html?partner=rss&emc=rss
