Vendor Sees Limit Up/Limit Down Problems

At least one data savvy player has drilled down into the Securities and Exchange Commission’s Limit Up/Limit Down plan and found it lacking.

Nanex, a provider of high-speed market data services based in suburban Chicago, simulated the impact of the regulator’s plan on the market of May 6, 2010, during the period of the now notorious “flash crash.”

Nanex discovered that 350 stocks would’ve triggered a pause or halt under the proposed circuit breaker scheme. The vendor concluded limit up/limit down would not have prevented the crash, but would’ve prevented the quick recovery.

“There are many, many problems with the proposal which have not been addressed by any of the comments to the SEC so far,” Eric Scott Hunsader, Nanex’s founder, told Traders Magazine. “They’re mostly from an implementation point of view.”

Hunsader outlines four key problems with the proposal. First, the determination of the average price necessary to calculate price bands will require too much computing power. Hunsader recommends using an exponential moving average, or one that assigns greater weight to the latest prices.

Second, because different systems are used by exchanges to process quotes and trades, the two are often out of sync. Hunsader recommends basing calculations on quotes only.

Third, the definition of ‘NBBO’ is unclear because exchanges rely on their own calculations of NBBO, not the one defined by Regulation NMS. Hunsader recommends the SEC to clarify the issue.

Finally, Hunsader predicts delays from the securities industry processors will result in latency arbitrage trading by those with the fastest machines.