If you've missed my previous posts on the Crash of May 6th, please go back and check them now - there are also many intelligent comments in the comment threads. The Best Ten Minutes You Will Spend This Weekend, Canceling Trades, Possible Triggers & HFT, and WTF Stocks?
I want to take one more post to explain what one of the problems was during the crash - and I think this will help with potential solutions, and with understanding what went wrong. First, we have a lot of different market centers now. The market is fragmented. That means that you can trade IBM on the NYSE, or alternative exchanges, ECNs (electronic networks) or dark pools. Reg NMS "protects" the NBBO - national best bid or offer. That means that regardless of what exchange (I'll use the term "exchange" instead of "market center" because it's easier, although these alternative market centers are not all technically "exchanges") you trade on, you have to trade at a price that is at least as good as the best bid or offer on all of the exchanges. This is a good thing.
The NYSE, however, has a provision called LRP - Liquidity Replenishment Points - which is designed to act as a sort of market speed bump during times of significant price movements. Many people are familiar with "trading curbs" we have for the major indices, which can result in altered or halted trading if the major indices move by a certain amount intraday. Well, the LRP is like a trading curb for an individual stock - it temporarily changes the stock from automated electronic matching to specialist controlled matching - the NYSE specialist steps in and tries to slow things down a tad while he sources liquidity and tries to pair off orders. In the NYSE's own words:
"A volatility control built into the Display Book to curb wide price movements resulting from automatic executions and sweeps over a short period of time. When triggered, LRPs automatically convert the market temporarily to “slow” or Auction Market only mode, allowing specialists, floor brokers and customers to supplement liquidity and respond to the stock’s volatility. "
This is also, potentially, a good thing. If people are worried about automated electronic executions - and it's pretty clear to me that people ARE worried - then the LRPs are a backup plan that take over in times of stress. Interestingly, the trigger thresholds are not very large - they depend on the price of the stock in question and its average daily volume, but for a stock like IBM the LRP would be triggered with a move of only $1 (that's not a $1 change on the day, it's a $1 change in a hurry).
There's one key issue, though: when the LRP is triggered, the NYSE's quote (behind the scenes - you wouldn't see it, but the market centers who "talk" to each other to make sure that you get the best price would see it) gets a special tag on it, essentially labeling it as "slow," and as a result it's no longer protected by Reg NMS as part of the NBBO. Essentially, all the other market centers and exchanges no longer have to honor the NYSE's prices, and can simply trade "through" the NYSE's bids.
Now, this is a problem. If we're going to have trading curbs in individual stocks, they need to be standardized across all trading venues! Furthermore, it's clear to me that since the NASDAQ wants to cancel trades that are out of line with prevailing prices, we do need individual stock curbs. Why on earth should the trades be allowed to happen at all if they are then going go be canceled? Be proactive - prevent the trades from happening in the first place!
What's funny is the back and forth between the exchanges in the aftermath. From the NY Times:
"The absence of a unified system to halt trading in individual stocks led to bitter accusations between exchanges on Friday. Robert Greifeld, chief executive of Nasdaq OMX, appeared on CNBC to criticize the New York Stock Exchange for halting trading for up to 90 seconds in half a dozen stocks on Thursday.
“Stopping for 90 seconds in time of crisis is exactly equivalent to not picking up the phone,” Mr. Greifeld said."
A few minutes later, Duncan L. Niederauer, chief executive of NYSE Euronext, responded in an interview on CNBC, blaming Nasdaq’s computers for continuing trading while the market was in free fall.
“These computers go out and just find the next bid they can find,” he said.
Mr. Niederauer acknowledged the need to introduce circuit-breakers along the lines of those already in place on the Big Board, and his views were echoed by some chief executives of the new exchanges.
I think it's likely that we'll see some sort of standardized individual stock trading curbs instituted as a result, which seems to be a pretty reasonable solution. I can only hope that curbs will be temporary (and by that, I mean that they will be in place for only a short time after they are triggered) and balanced - so that they aren't designed to put an extended halt to trading if stock prices fall, while continuing to allow trading if stock prices rise.