Will a New Trading Circuit Breaker Help?

06/08/2010 12:01 am EST

Focus: STRATEGIES

Last week, New York-based NASDAQ OMX Group Inc. (NDAQ) announced its intention to launch a single stock circuit breaker known as Volatility Guard. This circuit breaking technology proposes to protect investors and companies by curbing trade when the stock reaches or overtakes a certain predetermined threshold level.
 
As the name suggests, the Volatility Guard is aimed at controlling the excessive unpredictability that the equity market witnesses at times, thereby safeguarding the interests of all the market participants. On May 6, for instance, markets suffered a 1000-point intraday market crash. This dip was due to a lack of bids precipitated by the Greek crisis. This caused excessive volatility and anomalous trading, which plunged the markets, eroding $862 billion of investors’ wealth in a matter of 20 minutes.
 
NASDAQ’s volatility dampening tool, which has been rolled out following the SEC’s announcement on May 18 to institute circuit breakers, will halt trading on all the tickers that are listed on its market provided the stock experiences a change of 3% to 15%. However, the stock price will be the determining factor for the trigger to buzz. For example, a stock price under $1.75 would require a 15% price move; between $1.75 and $25 a 10% move; between $25 and $50 a 5% move; and over $50 a 3% move. The exchange will pause trading for a full 60 seconds every time such volatility occurs. The data would be unanimously available before, during, and after the trading pause. Besides, all market participants will be able to see the reopening process, thereby providing greater transparency in the markets.
 
With the implementation of this Volatility Guard, NASDAQ will fall in line with NYSE Euronext (NYX), which has had a similar system since 2006 to curb trading in the event of excessive fluctuation. The NYSE circuit breaker is known as the Liquidity Replenishment Point (LRP) model.
 
However, NASDAQ’s Volatility Guard features do not match with the SEC’s proposed pilot plan of a circuit breaker for the S&P 500 stocks, which requires a trading pause in all the stocks for five minutes if the stocks witness a decline of greater than 10% within a five-minute period.
 
NASDAQ’s Volatility Guard, which is expected to be effective from the third quarter of 2010, will supplement SEC’s pilot plan. The pilot program, which will be implemented within a fortnight, is scheduled to expire on December 10, 2010.
 
The SEC’s proposed market-wide circuit breaker is one measure to keep markets in check. However, other regulations have to fall in place as well to prevent further market plunges like the May 6 fiasco.

By the Staff at Zacks Investment Research

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