Diminished transparency at the start of the trading day and a slew of automated trade orders may have contributed to the steep plunge in exchange traded funds Monday morning before moving back in line once market makers stepped back in.

The New York Stock Exchange invoked Rule 48 in an attempt to prevent panic trading at the market open on Monday. The rule is typically invoked during extremely volatile market conditions and affects the ability of designated market makers to disseminate price indications before the opening bell. Stock market floor managers typically approve stock prices before trading begins, but with Rule 48 in effect, stock prices were not announced at the start so trading could get underway sooner.

However, with many stocks being halted shortly after opening Monday morning, the diminished transparency into prices may have affected market makers’ ability to calculate at what price to step in. Consequently, market makers stepped out of the way, allowing the market to price in orders before they were able to set their own prices, and waited for more precise numbers to come in.

Market makers are a major component in providing fluid exchange traded pricing. ETFs are traded on a primary market where market markers and the ETF sponsor help create and redeem ETF shares for underlying securities or holdings, which occur at the net asset value of the ETF, through so-called in-kind transactions. [How ETFs Are Traded]

Behind the scenes, the market maker would tap into the underlying benchmark to acquire the necessary liquidity to back the large ETF trade. The authorized participants or large institutional investors would swap a basket of securities from the underlying benchmark index for ETF shares, or vice versa.

Without pricing clarity Monday morning as trading on some securities were halted, market makers were unable to accurately facilitate normal arbitrage opportunities between an ETF’s price and that of its underlying securities.

Additionally, the mini crash in ETFs may have been further exacerbated by automated stop-loss orders that immediately turned into open market orders. [Stop Order Drawbacks]

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