NYSE Limiting Program Trades in Six-Day Test : Plan to Reduce Volatility Could Become Permanent
The New York Stock Exchange, worried about the possibility of another sharp plunge in the stock market, said it will reimpose limits on computerized program trading beginning today. In a six-day test aimed at preventing excessive price swings, the exchange asked its major firms to temporarily stop using its main automated system for program trading--which revolves around rapid computerized buying and selling of stocks and stock index futures--if the Dow Jones industrial index rises or falls 75 points or more from the previous day’s close.
The action, which will be reviewed after the test ends on Jan. 22 to consider making it permanent, was prompted in part by fears that the report on the nation’s trade deficit scheduled to be released this morning might cause a huge price swing on the stock exchange that would be exacerbated by program trading.
Immediately after the Oct. 19 stock market crash, NYSE Chairman John J. Phelan Jr. moved to prevent program trading on the exchange’s computerized execution system. Those restrictions, without the trigger points in the latest plan, were in effect for several weeks and were aimed at easing the crushing demands on the exchange’s computer trading and limiting volatility in the market.
Faith in Market Shaken
“We are concerned about market volatility and the impact it has on investor confidence,” said Richard Torrenzano, a spokesman for the NYSE. The decision followed consultations with senior officials of the exchange’s major member firms, who were “extremely supportive” of the plan, Torrenzano said.
Even if the restrictions go into effect on a certain day, Torrenzano said, automated program trading could resume on the following day.
Some traders criticized the NYSE’s decision, but it was widely supported by analysts who worry that sharp ups and downs in the stock market have scared away potential investors.
“If the industry does not regulate itself responsibly,” said Hugh Johnson, chief investment officer of First Albany Corp. in Albany, N.Y., “Congress will do it for us. I think this is one of many steps that will be needed to restore confidence in the markets.”
Program trading involves a wide variety of trading strategies used by “index arbitrageurs” attempting to take advantage of small differences between the price of stocks on the New York exchange and index futures--representing groups of major stocks--trading mostly on Chicago futures exchanges.
The use of computers to determine such moves allows huge blocks of shares worth hundreds of millions of dollars to trade between investors at an extremely rapid pace. The practice has been criticized for contributing to excessive market swings.
The recent Brady Commission report, however, suggested that restrictions imposed on program trading on the day following Black Monday’s record 508-point plunge in the Dow may have made the situation worse on Tuesday, when the trading system nearly broke down in disarray.
Limits Reduce Cash
The stock and futures markets “disengaged” Tuesday morning, the report said, because index arbitrageurs were unable to make trades that might have helped bring the two markets into closer balance. Futures and options trading was suspended around noon on Tuesday, Oct. 20, primarily because trading in stocks of many major corporations was extremely erratic.
Program trading is not the source of extreme market volatility, contended Courtney D. Smith, vice president for futures trading in the New York office of Banque Paribas. “Program traders are an easy target,” Smith said, “but the danger is that you reduce a major source of liquidity (cash) for the markets that serves an extremely important function.”
Despite the Brady Commission’s conclusions about the crash, Robert G. Kirby, a member of the commission and chairman of Capital Guardian Trust Co. in Los Angeles, said he was “extremely delighted” by the NYSE’s decision. He viewed the move as a “first step” toward ending program trading, predicting that before long major program traders “will voluntarily surrender” their operations.
“Once you can no longer trade a $100-million basket of stocks with a single push of a button,” Kirby said, “some people will finally get up the nerve to return to the stock market.”
NYSE spokesman Torrenzano also dismissed the Brady Commission’s suggestions that program trading was not at fault in the near-meltdown of the market. “They’re entitled to their opinions,” he said, “but obviously we think this move will help.”
The latest action to calm the recent extreme ups and downs in the markets came a day after one of the nation’s major futures exchanges established for the first time permanent daily limits on price movements of a particular stock index future. The step by the Chicago Board of Trade imposes a trading halt if major market index futures or institutional index futures rise or fall by a specified large amount in a single session. The limit on the MMI futures is roughly equivalent to a swing of 200 points in the Dow Jones industrial index.
Other futures exchanges have temporary limits still operating that were imposed after the October stock market crash and are considering steps to make them permanent.
The various markets appear to be taking voluntary steps in line with recommendations of the week-old Brady Commission report to consider price limits on index futures in conjunction with trading halts on the stock exchange as possible “circuit breakers” aimed at preventing a rerun of the stock market collapse.
