The so-called “Flash Crash” of May 6 raised concerns about the ability of stock exchanges to control run-away volatility. May 6 was the day when the Dow Jones Industrial Average plummeted over 700 points in the space of a few minutes, before an equally violent rebound wiped out most of the losses. Although the exact causes of the crash are still being investigated, SEC Chief Mary Shapiro pointed a finger at broker-dealers at recent Senate hearings: “It appears that some professional liquidity providers temporarily did not participate in the market on the buy side in many stocks that suffered particularly egregious price declines, whether because of an intentional decision to withdraw or because of specific market practices.”
The culpability of broker-dealer market-makers is up for debate, but there is no doubt that lack of transparency played an important role in the mini-crash. It is instructive to compare how the two major American exchanges, the New York Stock Exchange (NYSE) and NASDAQ, are planning to respond to violent volatility swings in individual stocks.
NYSE’s current volatility control program is called Liquidity Replenishment Points (LRP). When triggered by predefined price movements, LRP disables automatic execution programs on a volatile stock, allowing only “slow” execution of trades. By allowing only manual auction of the triggering stocks, specialists, floor brokers and customers have an opportunity to inject liquidity into the market. After a manual trade or predetermined time period, automatic execution can resume. Currently, LRP slows trading but is not a trading halt, nor does it provide enhanced transparency of buy and sell orders to the public. On May 26, NYSE filed a request with the SEC to extend LRP to include individual trading halts when a stock moves 10% or more in a 5-minute interval. The halt will remain in effect until the trade imbalance has been corrected. This will be a pilot project for stocks in the S&P 500 for which the NYSE is the primary market maker. It is slated to begin on June 7 and run through December 10.
On June 2, NASDAQ announced a new volatility control program called Volatility Guard (VG). It is a single-stock trade pause regime that is triggered when a stock moves beyond a predetermined Triggering Price. The Triggering Price for each NASDAQ-listed security is the price of any execution by NASDAQ in that security within the prior 30 seconds. The Threshold Range will be determined as follows:
|Execution Price||Threshold Range Away From Triggering Price|
|$1.75 and under||15%|
|More than $1.75 and up to $25||10%|
|More than $25 and up to $50||5%|
|More than $50||3%|
The pause duration will be 60 seconds. VG will apply to all NASDAQ-listed S&P 500 stocks. NASDAQ promises VG ”will allow data to be universally available before, during and after the trading pause. Additionally, the reopening process will be available to all market participants for better price discovery.” VG’s planned pilot implementation is set for June 14, also running until December 10.
While the amended LRP program and the VG program are basically similar, NASDAQ promises to offer enhanced visibility into the halt process. This “clear look” should increase liquidity by lowering the risk of misperceiving demand and supply for all traders. The VG circuit-breaker can be activated within 30 seconds of a violent price movement, whereas LRP requires up to a 5-minute interval. Finally, VG’s trigger mechanism is adjusted for stock price, whereas LRP’s trigger is set at 10% across the board. Time will tell whether these volatility programs are effective, and if so, which one is superior.