New "Circuit Breaker" Imposed To Stop Market Crash 460
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.'"
Good Fix... (Score:5, Informative)
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:Why do traders have such worst-case rules? (Score:2, Informative)
.. but why is the trading so frenetic in the first place? Why this absolute pressure to trade nownowNOW?
The stock market is a theoretical long term investment. It was before glass-seagul was appealed.
Here is how flash trading works. Basically a super computer sits below the trading floor watching incoming and outgoing transactions. Lets say you have $300,000 in savings and want to put $100,000 in company A as its stock price looks reasonable. It lists for $16 a share and you put down your $100,000 in shares. The super computer sees this HUGE grab and your transaction. It quickly buys all your shares before your transaction is complete and raises the price to $18 a share before your transaction is complete. Goldman Sachs or the other firm takes $2 from you in the process as you end up with less shares due to it becoming $18 a share within a few hundred milliseconds. Here is an illustration [imgur.com]. The same firms do the same when selling so if you decide to dump a stock at $18 you end getting only $16 a share and Megabank makes another $2 a share.
Its used like this and here are some more details on how it works [dailyfinance.com]. SHorting is quite popular and caused Greece some turmoil. The same is true with investors shorting bank stocks and mortgage backed securities in 2007. Flash trading was likely the culprit as it could do this in ways you and I could not imagine.
The original crooks of the 1929 stock market crash complained after Glass-Seagull that they could not run the stock market with games like they used too and it was no fun anymore. It looks like its returned to just that today.
Re:Why do traders have such worst-case rules? (Score:3, Informative)
Not even that. You can easily lose more than what you set because of situations like this. If it moves faster than you can sell for that amount, you will sell at below your stop loss number. You can set it at 40% and lose 99% (as some did here, though many of those were rolled back).
Re:The 'stock market' is just another form of gamb (Score:5, Informative)
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.
Re:Good Fix... (Score:4, Informative)
Arbitrage exploits inefficiencies, but it also reduces them. If there's a buy order in Market A for $50 and there's a seller in Market B who wants $49, then there's really nothing wrong about offering him $49.10 and then turning around and selling it in A and pocketing the $.90. (Real arbitrage usually would involve higher quantities and lower spreads.)
There are plenty of other people who would be willing to arbitrage the same thing as you are and give the guy on the other end a slightly better deal. So you'd expect that the profits that come from it are reasonable, and in line with the profits you could make by taking the money and effort of building a high-frequency trading system (programmers, fast computers, the risk of losing money on a bad trade, etc) and applying it elsewhere. It's really not a big deal.
As for a look at an extreme version of what the market would be like without people playing high-frequency trading games and the like, go look up your favorite small- or mid-cap stock on E*Trade during extended hours trading some time. Right now, my company stock can be bought for $12.30, or sold for $11.80. That's like a 4% fee to buying the stock. Yow! (The annualized real rate of return of the stock market is about 4%. That's like a year's profit, just gone, if you have to take those prices.) If big trading outfits can reduce that spread, they're welcome to whatever profits they can make off my money.
Re:No, HFT is a front-running scam (Score:2, Informative)
Except the limit price is not hidden, and can't be hidden, as a matter of principle. You can just look at the order book to see the distribution of orders at different prices. The order book is the "instantaneous" supply and demand curve.
Re:It's worse than that. (Score:1, Informative)
http://www.nyxdata.com/arcabook [nyxdata.com]
You can pay to view every order on the NYSE and NASDAQ, with 5 ms latency. It's not even that expensive, though out of most retail trader's reach.
That "Seeking Alpha" link is bullshit. Limit orders are not, and cannot be, confidential. How are market makers supposed to match buy and sell orders if they don't know the prices?
Re:Good Fix... (Score:4, Informative)
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).
Not only is a trade "directly" linked to the true value of a stock (or whatever is being traded) but it defines the true value of the thing being traded. The true value is what the buyer and seller agree to.
Re:Good Fix... (Score:5, Informative)
>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.