RSS
New Exchange Rules Started Today
The “flash crash” that occurred on May 6th was a scary event for most investors. The Securities and Exchange Commission agreed to a stock-market “circuit breaker” yesterday that will be a first step at preventing another “flash crash”. For more information, see our previous blog post titled “Should You Prepare for the Next ‘Flash Crash’?”.
As you may recall, the “flash crash” caused some shares to drop in value to as low as one penny. The Dow Jones Industrial average (DOW) dropped 1000 points in just a few minutes and then recovered by more than 600 points, just as quickly. To date, no reason has been found for the quick crash and recovery. It seems likely that computerized trading was somehow involved and possibly caused some hedge funds to retreat to the sidelines. This caused a lack of liquidity for some Exchange Traded Funds (ETFs) and some stocks.
An article in today’s Wall Street Journal (June 11, 2010) titled ‘Circuit Breaker’ Set, by Fawn Johnson, outlined the details of the new rule. The change implemented today will be in effect on a pilot basis for a period of six months. Only stocks included in the Standard & Poors (S&P) 500-stock index are initially affected. The new rule calls for all exchanges to stop trading for five minutes if a stock in the S&P 500 Index drops more than 10% in the previous five minutes. This will hopefully allow traders to assess whether such a quick drop in price of a stock is due to a real change in value or whether it’s due to some market anomaly.
This first step does not include small-cap stocks or index-based products such as ETFs. According to the article, Mary Schapiro, SEC Chairman, hopes to soon expand the circuit breakers to cover other stocks and ETFs.
Since no definitive cause has been determined for the “flash crash”, no one can be sure the new circuit breaker rules will prevent a similar incident in the future. Nevertheless, it seems a logical step in the right direction. Clearly, it seems that market volatility is here to stay and we can expect additional market crashes in the future. Investors, therefore, need to make sure that their portfolio allocations are in line with their risk tolerance and that they have sufficient cash on hand to weather future market downturns.
As you may recall, the “flash crash” caused some shares to drop in value to as low as one penny. The Dow Jones Industrial average (DOW) dropped 1000 points in just a few minutes and then recovered by more than 600 points, just as quickly. To date, no reason has been found for the quick crash and recovery. It seems likely that computerized trading was somehow involved and possibly caused some hedge funds to retreat to the sidelines. This caused a lack of liquidity for some Exchange Traded Funds (ETFs) and some stocks.
An article in today’s Wall Street Journal (June 11, 2010) titled ‘Circuit Breaker’ Set, by Fawn Johnson, outlined the details of the new rule. The change implemented today will be in effect on a pilot basis for a period of six months. Only stocks included in the Standard & Poors (S&P) 500-stock index are initially affected. The new rule calls for all exchanges to stop trading for five minutes if a stock in the S&P 500 Index drops more than 10% in the previous five minutes. This will hopefully allow traders to assess whether such a quick drop in price of a stock is due to a real change in value or whether it’s due to some market anomaly.
This first step does not include small-cap stocks or index-based products such as ETFs. According to the article, Mary Schapiro, SEC Chairman, hopes to soon expand the circuit breakers to cover other stocks and ETFs.
Since no definitive cause has been determined for the “flash crash”, no one can be sure the new circuit breaker rules will prevent a similar incident in the future. Nevertheless, it seems a logical step in the right direction. Clearly, it seems that market volatility is here to stay and we can expect additional market crashes in the future. Investors, therefore, need to make sure that their portfolio allocations are in line with their risk tolerance and that they have sufficient cash on hand to weather future market downturns.
posted by David C. Patterson and Erin Preston at
4:13 PM
1 Comments:
Wow, one of the best read posts so far.
Post a Comment
Subscribe to Post Comments [Atom]
<< Home