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Markets: We've often talked about the risks of extreme volatility inherent in our new fragmented electronic markets and possible dangers invited by not reinstating a potent uptick rule. Thursday was another case in point.
The wild gyrations in both individual stocks and market indexes confirmed our worst expectations. After the close, we heard that some of the most damaging trades, perhaps due to an erroneous keystroke, would be canceled. This is not a solution and could even makes things worse.
We've surrendered control of our markets to the premise that fast is always better. Thursday's action spoke otherwise. Our overbought market had been correcting for two weeks because of fears over the debt crisis in the euro zone, wild currency fluctuations and the unwinding of the carry trade. These kinds of factors have roiled markets forever. More important, investors large and small can understand them to a degree.
On Thursday, however, something far more dangerous took place. Sometime after 2:40 p.m. New York time, the markets were slammed by a wave of electronic selling that sent the Dow Jones industrial average to a record 1,010-point intraday decline.
Most of the damage was done in a 15-minute span during which the Dow plummeted 700 points only to bounce back 600 to close with a more modest 348-point loss. Big Board volume was the second-heaviest on record, and Nasdaq trade was the busiest ever.
More inexplicable was the action of certain individual stocks. The sell-offs and run-ups in blue chips such as Procter & Gamble, Apple, Microsoft and 3M were so sharp and sudden, they took even seasoned traders' breath away.
So what happened? Pick your favorite electronic buzzword: an erroneous (fat finger) order, a runaway program trade, a mutant algorithm, an errant high-frequency trading platform, a bungled black box, a loose quant program. But it doesn't really matter.
What matters is what didn't happen. No one was there to say "Stop! Something looks wrong here" or "Let's slow things down and avert a potential catastrophe." It appears that a stronger uptick rule with some teeth is needed.
Short-sell short orders had few controls to prevent them from worsening the declines. When NYSE circuit breakers slowed trading in selected stocks for 90 seconds (wow, such a long time!), giant sell orders simply migrated to ECNs or the Nasdaq, where no similar collars existed, seeking any bid.
No one applied the emergency brake. That is what can happen in fragmented markets with no central system of price discovery. Volume is spread among so many trading platforms and exchanges with different rules and oversight (the NYSE transacts only 28% of total volume). It's like the Wild West with no sheriff.
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