In the wake of the so-called “flash crash” that sent the markets gyrating on May 6, the Securities and Exchange Commission (SEC) has proposed implementing temporary circuit breakers on all S&P 500 stocks that should help prevent similar occurrences in the future.
The system works like this: The circuit breakers will pause trading in those stocks for five minutes if the price moves by 10% or more in a five-minute period. The circuit breakers will apply both to rising and falling stock prices, report Edward Wyatt and Graham Bowley for The New York Times.
Before the rules are implemented, the SEC will have a 10-day comment period. After that, if approval is given by the five-member commission, the trial run will go through Dec. 10. Once the trial period ends, exchanges will re-evaluate the rules and may ultimately extend them to all stocks permanently.
The SEC also said that the exact cause of the flash crash has not been found, but that in general a few things may have contributed:
- Traders stepped back and refusing to either buy or sell stocks and futures.
- The SEC also discovered a reliance on automated sell orders at the market price.
- There are different rules on different exchanges about when trading is automatically slowed or stopped.
What have been ruled out as causes of the crash: fat finger trades, computer hacking and terrorism. [How to Mitigate Market Volatility With ETFs.]
Since ETFs are not included in this initial round of rules, ETFs will still be subject to larger bid/ask spreads, as they will still be trading while some of their underlying components halt trading. Authorized participants (APs) will be forced to set the bid/ask by estimating the value.
Will the intraday indicative value (IIV) include the halted price of the underlying stocks? If so, will the AP honor that price when setting the bid/ask? We suspect that prices would be more realistic than the unreal prices used in the flash crash. [How to Put Cash Back to Work.]
For more stories about ETFs, visit our ETF 101 category.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.