Commentary: New Circuit Breakers Let Markets Call 'Time Out'
Traders Magazine Online News, June 29, 2010
On June 10, the SEC approved new single-stock circuit breakers in response to the May 6 market "flash crash." The SEC action permits the national securities exchanges and FINRA to implement uniform, market-wide "circuit-breakers" so that U.S. equity markets can take a "pause" in the event that there are rapid, excessive price movements in certain individual stocks.
These new rules will supplement the existing market-wide circuit breakers, which halt trading for varying periods of time if the Dow Jones Industrial Average falls 10 percent, 20 percent or 30 percent from the previous day's closing price. Those market-wide circuit breakers were not tripped during the flash crash, even though a number of individual securities dropped precipitously--and almost as suddenly reversed the plunge. The new circuit breakers are intended as a more targeted mechanism that will not depend on overall market declines.
The single-stock circuit breakers will pause trading in any component stock of the S&P 500 Index in the event that the price of that stock has moved 10 percent or more in the preceding five minutes. The pause generally will last five minutes, and is intended to give the markets a hiatus to attract trading interest at the last price, as well as to give traders time to think rationally.
The new circuit breakers will be effective on a pilot basis through December 10. In order to begin this pilot program promptly, the single-stock circuit breakers initially will apply only to S&P 500 component stocks. As currently adopted, these single-stock circuit breaker rules will not be in effect during market opening and closing, but only from 9:45 a.m. until 3:35 p.m. They are expected to be rapidly expanded--by additional rule proposals--to include ETF and other securities before the end of the pilot period. Several exchanges already have filed for rule amendments to halt trading in options when an underlying security is the subject of a trading pause.
The mechanics of the new rules provide that if a covered stock experiences a 10 percent change in price in a five-minute period, the stock's primary listing market will issue a five-minute trading pause and will immediately notify the other exchanges, FINRA, and market participants by disseminating a special indicator over the consolidated tape. Once the primary market issues the trading pause, each other exchange also will pause trading and FINRA will pause trading by its members in the OTC markets--including trading on alternative trading systems and by market makers.
At the end of the five-minute pause, the primary listing market will reopen trading. However, in the event of a significant imbalance on the primary listing market, it may delay reopening for up to an additional five minutes. Trading on the other exchanges and in the OTC markets will resume once trading has resumed in the primary listing market or, if the primarily listing market has not resumed trading within 10 minutes, the other exchanges may resume trading without waiting for the primary listing market. FINRA's rule permits OTC participants to resume trading only if trading has resumed on at least one exchange.
The SEC is hoping these single-stock circuit breakers will be a starting point in the effort to prevent another flash crash or runaway market. During the trial period, the SEC will consider, among other things, whether the 10-percent threshold is the proper measure for all securities (or whether the threshold should be commensurate with a stock's volatility), whether the length of the pause is sufficient to restore rationality to the market (if in fact it does that at all), whether these circuit breakers also should be in effect during the high-volume periods of market opening and closing and whether the reopening procedures work well. They may also be considering proposed alternatives to the circuit breaker mechanism.
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