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.'"

Comments

Good Fix...

[LostCluster]

What happened on May 6th was that sell orders were present without matching buy orders for an instant, and that allowed some really wacky trades to complete... nearly every Dow and S&P 500 component was affected, and some ETFs even traded for a penny a share for that brief instant. Then when news got out that there was bargains to be had, the buy orders started showing up and things returned to a run-of-the-mill down day.

Now, the NYSE and NASDAQ have always had this circuit breaker rule that allowed them to call a "time out" where they wouldn't process orders in order to draw attention to the wacky situation and give all involved time to react. The problem is that these new "market centers" allow trades to be completed rapidly, but also without the same oversight rules. While the big exchanges had the time out in effect, orders simply routed around them and the wacky drop continued. So, now the SEC is taking the NYSE/NASDAQ rules and making them their rules, so all the new players have to observe the timeouts. That should fix this problem.

Re:Good Fix...

[brian0918]

Millisecond trading is exploiting the system

I don't think that word means what you think it means.

It just sucks profit out of tiny variations in the market.

How does one go about "sucking profits"? What does that even mean? If you're going to advocate telling people how, with whom, and when they are allowed to buy or sell items with other willing individuals, you should at least have the common courtesy to clearly explain why such voluntary trades should not be permitted to occur.

Re:Good Fix...

[Jake73]

Actually, the term is "arbitrage" (http://en.wikipedia.org/wiki/Arbitrage) and it really is "sucking profits". It is exploiting (yes, I mean that) small variations and inefficiencies in market representations. These points are being closed, but they still exist.

Re:Good Fix...

[bertok]

It's allowed because the current theory is that anybody who wants to do it, can. I think the best argument against that is it takes real estate close to the market computers in order to have a fast enough ping time to trade by the millisecond.

My fix for that situation would be to dumb down the market clocks to only timestamp to the second, and anything received in the same second gets the same priority, with randomness as the tiebreaker when needed. That should suck the life out of these vultures.

A second? How about once a day!

Explain to me just what a multi-billion company could do in under a second that would fundamentally change the value of their stock?

Think about it this way: there is no way for traders to gain information on the underlying asset of a stock second-to-second. There is no public source of information that fast! No corporation gets updates internally that quickly. Most of them only roll up their accounts for reporting daily, and some only get an internal update of their financial status monthly or even slower. Even if some huge announcement was made that suddenly changes the value of a corporation, what difference does it make if people get to sell their stock a second or a day later?

The whole concept of the stock market is to create a central point for people to invest in a corporation. How is buying and selling a stock in under a second anything at all like "investing"? It's pure gambling, milking the real investors of cents on every dollar, putting it into the pockets of traders that provide zero value to society. They produce nothing except market crashes.

Trades faster than a day should be simply outlawed, and it should not be possible to own a stock for a period of less than one day either. Real investors should investigate a company's fundamental value and invest for years, not sit there all day and shuffle money around like it's a game in a casino.

Consider this: if millisecond trades are possible, and make sense, then why not microsecond trades? Nanoseconds? Why should we stop there? Lets puts the exchange and the trader's computers on the same piece of silicon, and have them buy and sell stocks at gigahertz!

Re:Good Fix...

[thrawn_aj]

THIS! A million times THIS! Why do you have to write something so sensible when you know it'll never be done? Are you trying to depress us to death =p

Of course it's gambling, plain and simple. Even worse, because these SOBs don't even have the decency of common gamblers to use their own money for the purpose. The whole profession is based upon extracting stuff out of that little space under your fingernails and calling it gold.

The worst part of it is that these hucksters can (and do) cause real harm to productive brick and mortar businesses for no earthly reason (but the whim of the big trader).

Re:Good Fix...

[Jah-Wren Ryel]

Explain to me just what a multi-billion company could do in under a second that would fundamentally change the value of their stock?

You are begging the question. It isn't what a single company could do in under a second, it is what external events might occur to change the perception of a company's prospects. Given the hundreds of millions of events that occur every second it is no stretch to believe a handful of them are relevant to a single company, even if only minutely so.

Sure you become more vulnerable to cascade effects, but you also get plenty of benefits like significantly increased liquidity.

Re:Good Fix...

[turbidostato]

">>>Trades faster than a day should be simply outlawed
You just bought Ford stock an hour ago, and now you just learned that the company is declaring bankruptcy effective 5 o'clock today. Do you really want to be forced to keep that stock until 23 hours from now (when it will be worthless)?"

Didn't you read? On his account, there's no problem. You will need to wait for 23 hours... but everybody else will have to too!

Your stocks will be worthless (than any other's) in 23 hours if and only if those said others are allowed to sell sooner than you and *specially* sooner than the buyer's knowledge about the bankrupcy. If everybody *have* to wait for a sane amount of time, the same for everybody, you are just leveraging the field allowing for more competitors and better reasoned actions.

Now, what do you prefer? To compete with big traders on an equal foot or compete with your morning newspaper against their supercomputers under the trade ring?

"I agree with your idea of 1 second intervals, but not 24 hours. A lot can change during that time."

It is not what can change between intervals but how much time is allowed for you to digest it.

Re:Good Fix...

[lennier]

Sure you become more vulnerable to cascade effects, but you also get plenty of benefits like significantly increased liquidity.

Explain how stock trading liquidity is a benefit in and of itself - to human society and the Earth's biosphere - rather than as a benefit only to those wanting to extract wealth from the markets due to volatility.

Remember that extracting wealth from the markets and transferring it from one account to another is not the same thing as 'profit', because it reduces the wealth available to actual productive investment - the corporate processes which do not and cannot change any faster than the time it takes to gear-up a factory or harvest a crop.

Remember also that every trade on the market which is not directly linked to the true value of a stock actively destroys information because it introduces noise into the market, polluting the use of that stock's trading symbol as a measure of real wealth (rather than imaginary fantasy wealth).

Explain clearly how, despite the information-destroying nature of speculation, nevertheless 'providing liquidity' to enable this destruction of information is still a significant human benefit.

Show all your work.

Re:Good Fix...

[michaelhood]

What exactly is the "true value of the stock"? If your answer has anything to do with the future (future revenue, future earnings, etc.), please explain how you're able to know the "true value" of anything which has yet to happen.

This is an excellent point. No healthy public companies are trading wholly on their intrinsic value.

The intrinsic value (this is hardly the proper GAAP term, so I'm defining it briefly here) would be taking all of XYZ Company's assets and receivables and summing them. Then dividing amongst the "float" (number of shares issued).

So if XYZ has $1M in the bank, and is owed $500k (and we assume it's all collectable debt), then their value would be $1.5M. If they have one million shares issued, those shares are worth $1.50?

That's hardly how it works.

Why? The shares don't disappear into thin air at the end of their fiscal year. They'll make more money next year, and the year after that. But they might go bankrupt, or become obsolete in the market. We can't know these things with certainty, so we price the stocks accordingly ("risk"). But wait, what if they sign a big deal and suddenly their receivables go way up for this year? Well that's called speculation.

So now you have the way modern fixed equities (stocks in companies) are priced on our markets. Actual monetary value if the company was sold, plus or minus speculation/risk on perceived future monetary value. Oh, plus dividends, but those aren't nearly as important as they used to be.

TL;DR- It's not simple like you want it to be, and it shouldn't be. Speculation drives access to capital.

Re:Good Fix...

[alexhard]

>Explain how stock trading liquidity is a benefit in and of itself

The higher the liquidity, the lower the bid-ask spread. Illiquid assets have gigantic spreads, to the tune of tens of percentage points on their actual value.

Re:Good Fix...

[bertok]

Um, the whole event that we are discussing happened because liquidity (buyers at a market price) disappeared for a few seconds. That sounds like liquidity might be pretty important.

To see this, consider for a second how you'd feel about your bank account, if you didn't know from day to day how much your $5000 was really worth. That is what liquidity is, and I'll bet your daily behavior suggests you value it highly.

It's not as liquid as you think!

My bank account only allows a maximum of AUD 20K electronic transfers per day, for anything else I'd have to got into a branch,
which would take me over an hour, and even then, transfers between banks are batch processed once a day, during the night. Some transfers take several days to process.

Do you see the pattern emerging here?

Why is it that everybody is perfectly happy doing their banking, the most liquid of the ordinary assets most citizens have, on a daily basis, but for some reason corporations require their investment liquidity to be on a millisecond timescale?

No business model needs that, except for the day traders that want to generate profits at the expense of ordinary investors that aren't physically housed across the street from the Exchange data centre!

Great idea

[MrEricSir]

I'm so saddened by these stories about stock traders getting electrocuted. It was about time they added circuit breakers.

Why do traders have such worst-case rules?

[lennier]

More and more the markets seem decoupled from reality. Why is it so hyper-urgent for a trade to complete in milliseconds, even if it means selling at rock-bottom price? Isn't that just really dumb programming?

Imposing a global circuit breaker seems like one way of fixing it... but why is the trading so frenetic in the first place? Why this absolute pressure to trade nownowNOW?

These are real companies people are betting on. Companies have lives in the years to decades, and at best their profits are measured in quarters - and even that's far too short-term thinking compared to human society, the biosphere and the ecological damage our industrial activities are doing.

There just isn't any meaningful data that can be generated about the activities of corporations on the millisecond scale. Not really any on less than a yearly scale, if you think about it. The biggest news right now is the Deepwater Horizon oil spill, and what's the timeline for fixing that? Weeks to months.

What does society actually gain from ultra-fast gambling on the markets? Other than a cheap thrill and massively increased risk?

Re:Why do traders have such worst-case rules?

[lalena]

Exactly. Some of those automated trades were selling stocks at pennies on the dollar when there was no fundamental reason for that stock to be down at all that day. I would think the fact that these auto trades caused banks to lose millions would be the incentive for the banks to fix the system themselves.

Re:Why do traders have such worst-case rules?

[mysidia]

There just isn't any meaningful data that can be generated about the activities of corporations on the millisecond scale.

No, but there is meaningful data to be generated about the supply, demand, and liquidity of their stock on the millisecond scale.

I think you forget the stock is an asset itself governed by market forces, apart of and independent from the company itself. And valuation of the company and its profits barely effect its valuation at all, over sufficiently short periods of time.

What does society actually gain from ultra-fast gambling on the markets? Other than a cheap thrill and massively increased risk?

It's not actually gambling, necessarily. But for every investor, there has to also be a speculator, otherwise, the transaction won't ever get made.

Increased liquidity has a great advantage for society -- like the ability for businesses to obtain capital, for investors to get their money, for enterprise to thrive and generate more capital.

The average American's retirement also relies on all this "gambling".

Re:Why do traders have such worst-case rules?

[Z34107]

But does our market system value the lives of the African villages above one person's gee whiz' feeling of unboxing an iPod?

Our market system doesn't "value" iPods over Africans. Certain individuals, as evidenced by their gee-whizery, value their iPod more than your hypothetical African village. "Our market system" didn't compel our one person to buy an iPod - it simply let him. By lamenting the market outcome, you're really lamenting that people are free to make that choice in the first place.

This presupposes that the iPod-toting hipster is Wrong, that he should have fed Africa instead. But why stop at iPods? You likely have a computer, internet, electricity, utilities, and shelter. You likely have more money in your checking account than they have seen their entire lives.

Even if you have nothing, a single paycheck at minimum wage is more than billions of the developing world see in an entire year. Why does the market value your luxuries over "the lives of the African villages?"

The problem isn't that hipsters have iPods, that you're a hypocrite, or even that I'm a prick - we grow more than enough to feed everyone on the planet. Markets are merely choices - our hypothetical hipster can choose to buy an iPod, feed Africa, or do something else entirely because of our market system. The real problem is that, for much of the developing world, there is no choice - they have no such market.

Large swaths of Africa lack the requisite institutions for a free market - things like a functioning government. Were corruption and genocide to disappear overnight, Africa would still be locked out of the developed world's market because of our government, its tariffs, and its subsidies.

Not all the iPods in the world, nor even Cupertino, can fix all of that.

Re:Why?

[LostCluster]

The guy who needs protection is the poor sap who wanted to cash out his account at that point in time, who submitted a market order expecting to get $60,000 and having it execute and come back with $2700 for him. Should have used a limit order... but still, this just isn't "fair" and not likely to encourage people to invest in the market. So, that trade gets busted, he gets his stock back and gets to try again. Still, the market doesn't like busted trades either, so we need new rules designed to decrease the likelihood this will happen again.

Feedback systems don't work that way...

[mangu]

there is no way for traders to gain information on the underlying asset of a stock second-to-second. There is no public source of information that fast! No corporation gets updates internally that quickly

I have a degree in Electronics Engineering and had to go through three courses on feedback systems and servomechanisms. What you are proposing may seem sensible, but that's not how nature works.

Feedback control systems can become unstable, but inserting delays into the feedback loop is about the *worst* thing you can do to destabilize them. If you want to stabilize a feedback system you should insert a "low pass" filter in the loop, not a delay.

A delay means that a lot of change will accumulate and suddenly be released. Putting a one day delay would mean that all the buy or sell orders would be stored hidden somewhere and then, all of a sudden, the market would become aware of that trend.

A low pass filter is, more or less, like a moving average. With a low pass filter, the market would get information on the average of the last X hours or days of transactions. That way everybody would be allowed to update instantly, to a microsecond precision if they wanted to, their estimates of the market trends, but those would not be instantaneous trends, they would be longer range.

Instead of limiting how fast market transactions can be done, it would be much better to limit the speed of the information on the system. Do not divulge *every* price for every transaction, but only the average of some period. This average can be updated every nanosecond if people want so, it will make no difference.

Re:The 'stock market' is just another form of gamb

[Anonymous Coward]

The stock market has no basis in reality. They like to pretend it does, but it doesn't. There are all sorts of excuses and 'reasons' why it does, but it has no more basis in reality than paper currency.

The first part of statement was wrong. Then when you said your bit about paper currency you confirmed the fact that you simply don't understand economics. Instead, you're another gold standard guy enthusiast. I'm going to explain to you why that's not a good thing.

The price of gold is set by the quantity of gold available and the demand for it, as is everything else. Since the total quantity of available gold isn't related at all to the production in any other industry, that's a really poor measure of the economic status of any one nation.

Paper currency is easily manufactured, but the guy who makes it isn't guaranteed to win anymore than everybody else is guaranteed to lose. It's called supply and demand. If you print too much of it, you have inflation, and the paper will soon be worth nothing. If you take money out of circulation, you have deflation, and the paper is worth more. Consequently, that's exactly the same situation you have with gold. If we start mining a whole lot of gold, the price of gold comes down and you can exchange it for less things. If you start producing less gold, the price goes up, and you can exchange it for more valuable things. The value of everything in relation to everything else is constantly fluctuating, and you don't make it "stable" or more "real" by having a mineral or a very difficult to manufacture thing as your currency. It's all the same. If we suddenly print ten times more money than we currently have available, assuming everything else stays the same, the cost of everything product will go up because the people with that extra money in hand will be willing to spend more, people's salaries will go up, because employees will demand more money to compensate for the increased price of goods, and now everything you could buy with a $1 bill you buy with a $10 bill. But it's ok, because your salary will have gone from $70,000 / year to $700,000 / year. It's exactly equivalent and no actual value was lost anywhere.

clueless

[Anonymous Coward]

Hi,

Normally I would be content to sit by the sidelines but I'm jumping in just to clarify, there is a lot of misinformation swirling around this discussion, a lot of conjecture by smart people who really have little to no experience in high frequency trading which is rapidly becoming the new wall street boogeyman. HFT dramatically improves liquidity and price discovery. It has helped lead the way to more efficient markets, and for the most part helps stocks and various other instruments reach their "true" value faster than ever before.

There are a lot of whiners out there complaining about how HFT is somehow "not fair", while they continue to get taken to the cleaners by their brokers, the banks, and hundreds of other middle men. Why do you think the spreads are so tight on a lot of these markets? HFT. Believe me, the institutional brokers would like nothing better than to make very wide markets and charge you for the privilege. The vast majority of investors who are taking long term positions in the markets are not effected by intraday moves. If you got burned because you were trying to make a profit intraday then you got what was coming to you, because not only are you not as fast as most of the firms out there, but also not as smart. (sorry) Frankly if NYSE's attempt to "restore order" wasn't so entirely broken the price discrepency would have been even shorter lived. However, because of the steps their market took to restore order most savvy shops immediately routed around them in order to complete and start new transactions (as they should). Attempts to regulate the markets in this way will not work as expected, because they are introducing arbitrary rules which will largely be ignored by the really big players (dark pools anyone?). So far there has been no indication that the recent price drop was the result of an HFT strategy gone awry, but rather a temporary blip made worse because of an outdated mode of operation. I think an interesting experiment would be if all of the HFT shops pulled their liquidity (this would never happen), the results would be fairly disastrous for short term investors, unless you like getting worse prices.

Anyway, I don't want to rant any more. It is unfortunate that people aren't really looking at this from all angles. Competition is a good thing for everyone. It applies to Microsoft and Linux, but not the markets right? ...