TRADING CURBS : How Limits Work--or Don’t Work--to Stabilize Market
The Dow Jones industrial average dropped enough almost immediately after Friday’s opening to prompt the New York Stock Exchange to impose limits on computer-driven trading. These limits--spurred by the October 1987 crash--are designed to stabilize the market during periods of extreme volatility, giving traders more time to assess the market.
After just two minutes of trading Friday, the NYSE employed the sidecar procedure, in which computer-guided trades on the Standard & Poor’s 500 futures contract (traded on the Chicago Mercantile Exchange) were delayed for five minutes so that sellers could be matched with buyers. It was the 13th time the sidecar, created in 1988, has been used.
The sidecar is employed when the S&P; futures contract rises or falls 12 points from the previous day’s close--equivalent to about a 100-point decline in the Dow industrials. It was last used on July 19, 1995.
Six minutes into trading, the trading collar went into effect, and it was still in place as the final bell sounded. This, also known as a circuit breaker, is triggered when the Dow industrials move 50 points from the previous day’s close. When the rule takes effect, computer-guided orders can only be entered on stocks for which the price movement is in the opposite direction of the order being entered. In other words, when the Dow has fallen 50 points or more, computer sell programs can only be entered when the last price movement in the stock has been upward. The opposite holds when the Dow has risen 50 points or more.
The collar is removed if the Dow industrials recover to within a 25-point position from the previous day’s close. That never happened Friday.
Had the Dow fallen or risen 250 points from the previous day’s close, a trading halt of one hour would have been imposed on all U.S. equity and futures markets. And had the Dow then fallen 150 points further on the same day, trading would have been halted for two hours more.
The futures market has its own sets of curbs. For example, the 3-point down limit in the 30-year Treasury bond futures contract went into effect almost immediately, and it definitely affected trading there, as traders couldn’t get out after that. More selling might be possible Monday.
Do these curbs work in general, and did they help reduce volatility on Friday?
That depends on whom you ask. Some traders argue that in a stock market panic, the NYSE curbs may spark even more selling as investors try to get out to beat the limits.
Others argue that the curbs make sense and that Friday’s sell-off might have been worse without them. But some add that the trigger levels for the curbs need to be updated, as the 5,000-plus level of the Dow on Friday means that a 50-point move is less significant than it was when the Dow was below 3,000 during the 1987 crash.
