SEC eyes trading ‘circuit breakers’
Wednesday, May 12, 2010
By Michael Mackenzie in New York
The fragmented US equity market – where shares are traded via rapid-fire computers across some 50 different venues – faces a raft of new rules after last week’s wild swing in prices.
Chief among them is the introduction of circuit breakers for individual stocks.
As exchanges try to discover what exactly sparked the so-called “flash glitch”, when equities slumped and rebounded inside a period of 20 minutes, the industry is braced for a regulatory overhaul.
“I believe we ... must consider the various types of time-out mechanisms that can be applied to individual stocks,” said Mary Schapiro, Securities and Exchange Commission chairman, in testimony this week to a Congressional hearing.
Foremost is an industry-wide circuit breaker – it is suggested that the SEC will implement a brief trading halt in a stock if its price falls 10 per cent inside a five-minute period.
In the highly competitive world of US equity trading, however, there are plenty of opinions as to what kind of circuit breaker should be calculated and enforced across the array of exchanges, private platforms at broker/dealers and dark pools.
James Angel, professor of finance at Georgetown University, says the current system of trading halts in a stock ahead of a news announcement is a good place to start as all trading venues respect that rule.
Currently, the floor of the New York Stock Exchange enforces a system of curbs on stocks, which sprang into action last week.
That sparked complaints from other exchanges but the NYSE floor did not execute any erroneous trades.
Hence it had no need to cancel any trades, unlike at other electronic exchanges, including NYSE’s own Arca platform.
Any limits on cash equities need to be replicated across futures, options and the realm of exchange traded funds, which follow the prices at which individual stocks trade.
“You need circuit breakers in all markets and, while it’s feasible, there are a lot of moving parts and it will be harder to implement than people think,” says Anthony Conroy, head of trading at BNYConvergEx, an electronic brokerage.
Knight Capital Group, another electronic brokerage, proposes that once an individual stock drops 25 per cent from the previous day’s close, then trading should be halted for five minutes and that such a circuit breaker be uniformly applied across all areas of the market.
But individual stocks differ in terms of their liquidity and support by market makers – and not everyone thinks an industry-wide standard can be applied.
Nasdaq OMX Group told the Congressional hearing that they favour “a flexible approach that recognises that stocks trade in different ways, rather than a one-size-fits-all approach that treats all stocks identically”.
The introduction of circuit breakers may also not address the main lesson drawn by many from the trading “glitch”.
Justin Schack, director at Rosenblatt Securities, says the real issue is the amount of erroneous orders that flooded the market last week. As stocks fell, many traders stepped away from providing prices to buy them while sell orders kept arriving from investors with a mandate to execute a trade at the “market” or prevailing price.
In extreme cases, token 1 cent bids that were left on some exchanges by market makers were the only bid in the system and they were duly executed by computers.
“Maybe we need to place some type of limit on market orders so that they don’t trade at a price significantly different from the previous sale,” says Mr Schack.
That view is shared by Ms Schapiro, who told the hearing that the SEC will consider placing a “collar” on the price of a market order and limit aggressively priced orders.
Chief among them is the introduction of circuit breakers for individual stocks.
As exchanges try to discover what exactly sparked the so-called “flash glitch”, when equities slumped and rebounded inside a period of 20 minutes, the industry is braced for a regulatory overhaul.
“I believe we ... must consider the various types of time-out mechanisms that can be applied to individual stocks,” said Mary Schapiro, Securities and Exchange Commission chairman, in testimony this week to a Congressional hearing.
Foremost is an industry-wide circuit breaker – it is suggested that the SEC will implement a brief trading halt in a stock if its price falls 10 per cent inside a five-minute period.
In the highly competitive world of US equity trading, however, there are plenty of opinions as to what kind of circuit breaker should be calculated and enforced across the array of exchanges, private platforms at broker/dealers and dark pools.
James Angel, professor of finance at Georgetown University, says the current system of trading halts in a stock ahead of a news announcement is a good place to start as all trading venues respect that rule.
Currently, the floor of the New York Stock Exchange enforces a system of curbs on stocks, which sprang into action last week.
That sparked complaints from other exchanges but the NYSE floor did not execute any erroneous trades.
Hence it had no need to cancel any trades, unlike at other electronic exchanges, including NYSE’s own Arca platform.
Any limits on cash equities need to be replicated across futures, options and the realm of exchange traded funds, which follow the prices at which individual stocks trade.
“You need circuit breakers in all markets and, while it’s feasible, there are a lot of moving parts and it will be harder to implement than people think,” says Anthony Conroy, head of trading at BNYConvergEx, an electronic brokerage.
Knight Capital Group, another electronic brokerage, proposes that once an individual stock drops 25 per cent from the previous day’s close, then trading should be halted for five minutes and that such a circuit breaker be uniformly applied across all areas of the market.
But individual stocks differ in terms of their liquidity and support by market makers – and not everyone thinks an industry-wide standard can be applied.
Nasdaq OMX Group told the Congressional hearing that they favour “a flexible approach that recognises that stocks trade in different ways, rather than a one-size-fits-all approach that treats all stocks identically”.
The introduction of circuit breakers may also not address the main lesson drawn by many from the trading “glitch”.
Justin Schack, director at Rosenblatt Securities, says the real issue is the amount of erroneous orders that flooded the market last week. As stocks fell, many traders stepped away from providing prices to buy them while sell orders kept arriving from investors with a mandate to execute a trade at the “market” or prevailing price.
In extreme cases, token 1 cent bids that were left on some exchanges by market makers were the only bid in the system and they were duly executed by computers.
“Maybe we need to place some type of limit on market orders so that they don’t trade at a price significantly different from the previous sale,” says Mr Schack.
That view is shared by Ms Schapiro, who told the hearing that the SEC will consider placing a “collar” on the price of a market order and limit aggressively priced orders.