FOR A BRIEF BUT TERRIFYING TIME THURSDAY, the Dow Jones Industrials fell by almost 1,000 points. There still are no concrete answers as to why it happened, but there is much finger-pointing. Some blame high-frequency traders, a few of whom reportedly pulled out of the market just when their liquidity was needed. Others point to the NYSE, which enforced circuit breakers on certain stocks that had fallen sharply. Its action might have pushed trading onto other exchanges with less liquidity, resulting in lower prices.
Whatever the cause, the meltdown confirms that the market's infrastructure and regulation must catch up to changes that have taken place in the way stocks are traded. "This was a market-structure problem, exacerbated by high-frequency trading," says Richard Repetto, of Sandler O'Neill & Partners.
The Securities and Exchange Commission and the Commodity Futures Trading Commission are reviewing Thursday's activity. Let's hope they can explain soon why Accenture (ACN) plunged to a penny the same day it opened and closed around 41, a journey that hardly inspired confidence in the nation's financial markets.
When they uncover the mystery, regulators and market pros need to focus on ensuring that the exchanges and electronic communications networks, or ECNs, improve their operations to cope with market stress. Not least, it's time to ask whether faster, cheaper trades are helping the markets -- or just the high-frequency trading community.
Technology has helped spur the development of many new stock exchanges and ECNs in the past decade. As a result, the New York Stock Exchange, owned by NYSE Euronext (NYX), handles only 20% to 25% of the daily equity trading in its own listings. Typically, that's not a problem, but Thursday it was. When prices on certain stocks fell sharply, the NYSE stopped using its computers to trade shares automatically. Instead, its market makers did what they're supposed to do -- They started making markets in stocks such as Procter & Gamble (PG).
Moving to market makers, which can slow trading by a minute, kept P&G from falling below 56 on the Big Board, after opening at 61. But once the NYSE switches to market makers, other exchanges and ECNs can ignore its price. P&G swooned to 39 elsewhere that day, before closing where it began. An NYSE spokesman touted "the value of human judgment" in the trading process.
Critics claim that NYSE circuit breakers drained vital liquidity from the market and caused prices on certain stocks to gap down. The SEC said, in a press release: "We are scrutinizing the extent to which disparate trading conventions and rules across various markets may have contributed to the spike in volatility."
While Joe Ratterman, CEO of the BATS exchange, is "tending towards not having" circuit breakers on individual stocks, he believes what is most important is having all exchanges and ECNs follow the same rules.
The rise of high-frequency traders also has been a game changer. HFTs use computers to trade small, hundred-share lots of stocks in under a second, millions of times a day. Did they cut and run? Getco, a major high-frequency trader, said it continued to make markets throughout the day. Ratterman says roughly 19 billion shares traded Thursday, the second-highest total in history. And he adds: "You can't [trade] 19 billion shares if everybody has pulled out" of the market.
But doubts abound. The Wall Street Journal reported Tradebot Systems exited the market after the Dow dropped 500 points, so as not to worsen the problem. Joe Saluzzi, co-head of equity trading at Themis Trading, charges HFTs "don't supply liquidity when they need to. They provide liquidity when they want to."
What happened will amplify calls for more regulation of HFTs. Larry Tabb of the Tabb Group suggests there should be controls to prevent abnormally large trades from being executed mistakenly. The SEC, he says, also should move faster to ban naked access, or HFTs' ability to bypass regulated brokers and trade directly on an exchange. Tabb also suggests increasing the spread between bids and offers from a penny to five cents. Doing so might cost more, but it would slow trading and improve liquidity, he says of the controversial suggestion.
As Sen. Ted Kaufman (D., Del.) likes to say, "Liquidity is important, but it is always trumped by fairness and transparency." The markets need transparency now.
More From Barron's Afternoon Movers: Maidenform, Legg Lead Update: Comcast CEO Says Now Offering 70K Hours On Demand Citi: Deutsche Reiterates Buy, $5.50 Price Target
Want to read more from Barron's? Try Barron's Online for four weeks FREE! Click here.
Trackback URL for this story: http://www.smartmoney.com/tb/Jduu.2F98.3D
What is a Trackback?It is a way to tell us that you have published something that references this story.
How do I send a Trackback? If you blog or mention this story on your website, you can use this Trackback URL to notify us about it. Some blogging software programs can help in sending a Trackback to us.
Click here to read more about Trackbacks.
Market Mayhem Confirms Need for Better Regs http://bit.ly/at8R2Z via http://topicfire.com/Business
Read Full Article »