Circuit Breakers and High-Frequency Trading
On May 6th of this year, one trillion dollars of market value were erased from 2:42 – 2:47 pm. Entire funds traded for one cent and the Dow Jones Industrial Average crashed 1,000 points, but by the end of the day, companies’ prices again reflected their value. Known now as the “Flash Crash”, this five-minute fallout sparked public interest in modern trading and a recent change in the regulation of stock exchanges.
In the spotlight are high-frequency traders, who use microsecond-fast computers to trade on and clear out price discrepancies. 73% of U.S. equity trades are now high-frequency, and competition between traders to be the first to fill orders has led to closure of the bidding price and selling price gap in the 21st century, a modern boon which reduces to fractions of pennies transaction costs for all investors.
High-frequency trading before the Flash Crash was recently reviewed by the Securities and Exchange Commission, the U.S. government’s chief financial regulator. Although the commission reached no firm decision, “it does seem that it was the absence of the liquidity that the high-frequency traders provide that caused the large volatility of May 6th,” says R. Scott Morris, former Managing Director of Automated Execution at Goldman Sachs. “High frequency traders need fast, reliable price data from the exchanges to make tight markets. When that process broke down, they were unable to make competitive markets and were forced to completely pull out of the market. We know what happened next.”
To reduce the risk of another Flash Crash, the SEC began in June installing circuit-breakers on publicly-traded companies and funds. The breakers halt trading of an equity for five minutes if it exhibits a price swing of more than 10% in the preceding five minutes, and were turned on July 6th after an offer to buy 200 shares of Anadarko for 2500% of its price. However, concerns have been raised about the possibility that a single person can—willfully or not—enter an incorrect price and halt the entire market. Let’s hope this solution does not cause more problems than it solves.
Photo thanks to Freefoto.
Post new comment