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New "Circuit Breaker" Imposed To Stop Market Crash
Lucas123 writes "The SEC and national securities exchanges announced a new rule that would help curb market volatility and help to prevent 'flash crashes' like the one that took place on May 6, when the Dow dropped almost 1,000 points in a half hour. That crash was blamed in part on automated trading systems, which process buy and sell orders in milliseconds. The new rule would pause trading on individual stocks that fluctuate up or down 10% in a five-minute period. 'I believe that circuit breakers for individual securities across the exchanges would help to limit significant volatility,' the SEC's chairman said. 'They would also increase market transparency, bolster investor protection, and bring uniformity to decisions regarding trading halts in individual securities.'"
Yay, another lesson in efficient markets. Slowing down the "rate of trade" does not change the valuation. In this contrived example Ford after 24 hours is worth 0 and so everybody gets to sell at 0. Prices don't converge in any way, they just jump around. $50 a share, then $0 a share. This is not how the real world works. Nobody wants this, not Ford, and certainly not investors. Why should the valuation of the company be $0 after a declared bankruptcy? Does the company have no cash flow? No Assets? Can it restructure? Can I pump cash into Ford as its falling because I value it differently than you do? Who should decide what the company is worth after 24 hours, you? The bank? The guy down the street? I have a novel idea. lets let the MARKET DECIDE.
How exactly do you think valuation works? What are the factors involved? How should we determine when Ford is worth $0. If you feel slighted you should have sold before it hit 0, which you most likely would have had plenty of time to do because of the liquidity provided by market makerts and fast intraday traders, but instead since we had to wait that 24 hours everybody got the new valuation of $0. Everybody gets screwed equally!
Ok, if 24 hours is too long, lets set it to 12 hours. Too long? Ok... 1 hour. Still too long? How about once every 15 minutes?
No? How about once a femtosecond? Is that a fine enough temporal division for you?
It sounds farcical, but it already has become an insane joke played with trillions of dollars. Day traders are renting space across the street from stock exchanges to reduce the delay introduced by the speed of light, because those extra microseconds matter.
In the real world, if trades occurred on 24 hour ticks, Ford's stock price would NOT fall to $0. It would be a lot like an auction, people would put in the range of prices at which they are willing to sell or buy, and the exchange would handle the deals. Even if 100% of existing investors decide to sell, many buyers would want to buy, at say, $5, because of the inherent value of the company's physical assets. Selling at $0 makes no sense, that's the equivalent of tearing up money! Even if for some reason Ford's total net value became negative (debts), then the $0 valuation is exactly what the share is worth. The investor made a bad decision, and was burned. Better luck next time! Why should some traders walk away with more than what the value of their share? That's just moving money from one pocket into another, and the source of that money is often small investors, while the destination is an elite group of day traders. Why do they deserve that money? What have they done to earn it?
Note: In cases where there isn't enough liquidity between individual investors, the exchange itself should step in and provide liquidity, at an estimated price (minus a commission to the exchange to cover their risk). This isn't even unusual, certain kinds of exchanges do this now at some level.