Key Issues in the Aftermath of the Dow Jones Plunge
A look at some key issues facing the market overall and individual investors as trading opens today, after Friday’s 120.31-point plunge in the Dow Jones industrials:
HOW “CIRCUIT BREAKERS” WORK: In the aftermath of the 1987 market crash, the New York Stock Exchange and other stock and futures markets put in place several “circuit breakers” designed to cushion the market against a free-fall. The measures can’t stop a market plunge if sellers simply continue to outnumber buyers, but they can slow the decline by limiting the computerized “program” trading games played by big investors for short-term gains. The key circuit breakers:
* When the Dow Jones industrial average falls 50 points, a “collar” is implemented that slows program trading by limiting some such trades to “upticks”--which means the last trade in a stock had to be at a higher price than the one just previous, before another program trade can be executed.
* When the Standard & Poor’s 500-stock index falls 12 points, roughly equal to a 90-point fall in the Dow, program trading orders are put on a “sidecar” within the NYSE computer. This further slows such orders and allows small investors’ orders to go ahead of program trading.
* If the Dow falls 250 points, all trading is halted for one hour.
* If the Dow falls an additional 150 points (400 points in all), trading is halted for an additional two hours.
THE FRIDAY CURSE, REVISITED: Is it a coincidence that market routs happen so frequently on Fridays? The Dow Jones industrial average plunged 108.35 points on Friday, Oct. 16, 1987, which set up the 508-point dive on Oct. 19. In 1988, the Dow plummeted 140.58 points on Friday, Jan. 8. But on the following Monday, the Dow managed to rebound by 33.82 points. On Friday, Oct. 13, 1989, the Dow plummeted 190.58 points, only to surge 88.12 points the following Monday. One reason why Fridays are dangerous is because that’s a major expiration day for stock option and index-futures contracts, which roll over periodically. Because computerized program traders often play games with options and futures, trading them against individual stocks, a market plunge on an expiration Friday can become exaggerated as program traders dump their positions to “unwind” their trading games. Such trading helped propel the market’s steep selloff in the final hour last Friday: Of the Dow’s 120.31-point loss for the day, 70 points of that occurred in the last hour.
IS NASDAQ READY? When a wave of sell orders hits the New York Stock Exchange, a small group of people ultimately is responsible for dealing with the deluge: the “specialists” whose job is to match buy and sell orders for individual NYSE stocks. The presence of the specialists means there’s always a traffic cop on duty to handle order flow. In the NASDAQ market for smaller stocks, however, there is no individual specialist in one location--just a network of traders nationwide, connected electronically. A major criticism in previous market crashes is that some NASDAQ traders were either unable or unwilling to answer their phones when sell orders piled up, essentially leaving the market frozen. A big question this time around: After deep personnel cuts over the past two years, are brokerages’ NASDAQ trading rooms now too thinly staffed to handle a huge flood of sell orders? NASDAQ officials have played down those concerns in the past, but today may provide the litmus test.
TIPS FOR MUTUAL FUND OWNERS: If you own shares of a stock mutual fund, and you decide to call your fund and sell today, what price will you get? Most funds will execute a sell order at the closing price of the fund on the day the sell order is received. So if the market is dropping, and you decide to sell in mid-morning with the idea of avoiding a further decline later in the day, it probably won’t work: Chances are you’ll still get the day’s closing price. Some fund companies do make exceptions for stock funds that own shares only of specific industries. For example, the Fidelity fund company prices and sells its “Select” portfolios hourly. The Select funds generally own stocks in one industry, such as Select Biotech, Select Financial Services, etc.
WILL THE FED STEP IN? The Federal Reserve will face a severe dilemma if the stock market decline continues this week. In previous market selloffs, such as in October, 1987, the Fed was able to quickly step up to the plate and push interest rates lower to help pump more liquidity into the financial system. That gave brokerages and big investors easier access to cash, which they could use to buy stocks and thus help stabilize the market. Today, however, the Fed’s hands may be tied. The central bank has already pushed short-term interest rates to their lowest levels since the mid-1970s, trying to jump-start the economy. Though the Fed hardly would want to stand by if the stock market reached meltdown, many experts aren’t sure if yet another interest-rate cut would do much good. Moreover, the Fed is viewed as reluctant to ease credit further for fear of sending the wrong message to the bond market: Bond owners worry that if the Fed keeps credit too easy for too long, another inflationary spiral will begin.
