Halt trades or band prices?
That’s the debate taking shape in the aftermath of the May 6 "flash crash" and the swift imposition of circuit breakers by the exchanges on June 11. Some believe the circuit breakers-which, if triggered, halt trading in a given stock-are too draconian. They want to replace them with the "limit-up/limit-down" price banding in use by the nation’s futures exchanges.
"We need more discussion, rather than putting into place reactive measures like a circuit breaker that is hoped to be the answer to everyone’s problem," said Hirander Misra, chief executive of trading technology vendor Algo Technologies and former chief operating officer of Chi-X Europe. "To a certain degree, circuit breakers are a knee-jerk reaction. It’s trying to put in place a one-size-fits-all prescriptive solution for something more dynamic than that."
Under new rules implemented by the nation’s stock exchanges, if a given stock rises or falls by 10 percent or more in a five-minute period, trading in that security is halted for five minutes. The rule initially applied to the stocks in the S&P 500 Index, but could be expanded to hundreds of others.
Industry executives like Misra would prefer to see the circuit breakers morph into price bands similar to those used by the futures exchanges. With those, a futures contract is prohibited from trading outside a given range based on the previous day’s closing price. Trading in a given contract might be limited, for instance, to no more than 10 percent above or below the previous day’s close. A contract that closed at $3.00 the previous day, then, could not trade higher than $3.30 or lower than $2.70.
There are at least two major benefits to price banding, supporters point out. First, it prevents erroneous trades from occurring as they did on May 6, when approximately 20,000 erroneous trades were canceled. That’s because any order outside the band is rejected. Second, price banding allows markets to stay open-whereas with a halt, trading is stopped for a period of time.
Dave Cummings, head of proprietary trading house Tradebot Systems and founder of BATS Exchange, also believes price banding is preferable to trading halts. Following the trigger of circuit breakers reacting to a 17 percent plunge in the price of Citigroup on June 29, Cummings told Traders Magazine that "it was stupid to halt trading. Exchanges should prevent trades at clearly erroneous prices, rather than going haywire and shutting down. There is no reason to have a marketwide circuit-breaker halt that is tripped by a single obvious mistake."
Cummings has suggested one possible way to structure limits. Exchanges would define a limit down, for instance, as the low of the previous 5 minutes minus 10 percent. Then offers lower than that would be rejected. A low limit could be reset at the top of each 5-minute window. In the last 5 minutes of trading, the exchanges might reset the limit every minute. Similarly, the exchanges could define limit up as 10 percent above the previous high, Cummings told the SEC at a recent hearing.
At the exchanges, which would implement any price bands, there are varying degrees of enthusiasm for the mechanism. Some executives favor replacing circuit breakers with price bands. Others say the two can work together. Still others favor circuit breakers over price bands.
At a joint roundtable held by the Securities and Exchange Commission and the Commodities Futures Trading Commission in June, exchange executives noted that the fragmented nature of the equities market might work against the use of price bands.
NYSE Euronext executive Joe Mecane said it might be difficult to disseminate to the various markets the prices at which they are allowed to trade for certain intervals. He also noted that brokers’ ability to internalize orders might complicate the use of price limits as the brokers trade at the limit price. "There are potential unintended consequences that we might be able to overcome, but that complicate limit-up/limit-down scenarios," Mecane told SEC chairman Mary Schapiro.–Additional reporting by John D’Antona
