The single-stock circuit breakers introduced after the May 6, 2010 “flash crash” were not as disruptive as many people feared they would be, according to a report released on Tuesday by Credit Suisse.
Titled “Pardon the Interruption — The Impact of Trading Halts,” the report found that 51 percent of trading halts from June 2010 to September 2011 came after fundamental news emerged about a stock. In these cases, the appropriate price adjustment still occurred, but was postponed, the report found.
According to the report, the circuit breakers are potentially undesirable to some market participants who are looking to profit from a first-mover advantage. Still, exchanges already halt stocks when certain news is pending to allow investors time to digest all the relevant information.
When important news is released during trading hours without advance warning, circuit breakers can allow an orderly adjustment process in which market participants have time to correct for imbalances before submitting their orders, the report found.
“Certainly, some people will always view trading halts as a nuisance, but they may not be as negative as some people put them out to be,” said Ana Avramovic, an analyst at Credit Suisse.
About 11 percent of circuit breakers were triggered by a “fat finger” trade that temporarily throws a stock’s price out of line before the price reverts to its previous level. In these cases, circuit breakers are definitely helpful, as they prevent prices from being pushed way beyond fair value as other traders react to one outlying price.
“In the case of a fat finger, we’ve seen a number of trades come through, potentially drawing in other traders and extending the move. So in that case you want to nip it in the bud,” Avramovic said. “You’ve seen more than one trade, which means it has a potential cascading effect.”
Bad prints caused about 6 percent of trading halts, the report found. For this small number there is a definite disadvantage, as the market can easily identify a mistaken print and move on, but the circuit breaker delays that process.
About 32 percent of trading halts were in cheap or illiquid stocks. The report did not explicitly address these instances, and Avramovic said they tended to not have much of an effect on the overall market.
Overall, however, there were only a few occurrences where circuit breakers could be considered truly disruptive, the report found. Others were considered beneficial, or at worst, a nuisance.
The report pointed out that even with the halts, U.S. stocks still trade more consistently than stocks in many other developed countries where trading can be stopped for hours or days around important news events.
Currently, the Securities and Exchange Commission plans to replace the single-stock circuit breakers with a proposed limit up/limit down rule, which would introduce a pause for 15 seconds before enacting a full trading halt.
What is encouraging is limit up/limit down could eliminate trading halts caused by bad prints, Avramovic said. That would be an improvement over the current single-stock circuit breaker rule, she added.
Limit up/limit down still faces opposition from within the futures and options industries, since derivative products could still continue trading during a pause in the underlying equity, which would make hedging problematic.
