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August 1, 2010

Industry Ponders Limit Up/Down After Flash Crash

By Peter Chapman

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  • Industry Ponders Limit Up/Down After Flash Crash
  • Page 2

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.

Hirander Misra

"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. "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."

Under rules implemented by the 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 stocks in the S&P 500 Index, but might be expanded to include 334 exchange-traded funds.

Industry executives like Misra want 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 to no more than 10 percent above or below the previous day's close. A contract that closed at $3.00, for example, could not trade higher than $3.30 or lower than $2.70.

There are two benefits to price banding, supporters noted. First, it prevents erroneous trades from occurring. (On May 6, 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.

Dave Cummings, head of 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."