By Matt Hougan
Jim Wiandt's blog about market structure sniffed of false nostalgia for the 'good old days' of specialists and human trading.
He's not alone. Everywhere I go, people seem to be pining for the old days of specialists, slow markets and stock trades measured in fractions. (Remember the "teenie"?) I received tons of “told-you-so” e-mails about the need for specialists following the May 6 flash crash; I heard variations of it at our recent Journal of Indexes board meeting; and I continue to get questions about it from reporters.
The old days weren’t so good, unless you were a specialist. It was moolah-city for the specialists back then. The number of Lamborghinis parked within three blocks of the New York Stock Exchange during the “good old days” was sky-high.
But guess who was paying for those fancy cars? You and me. Trade by trade by trade.
I agree with your central contention that market structure outran regulators. The fractured market, coupled with Regulation NMS, removed the safeguards of the old-guard specialist system without replacing them with technological fixes. Synchronicity in algorithmic trading activity then set the stage for the “perfect storm” we saw on May 6.
But let’s remember what really happened during the flash crash: The market fell 10 percent, and then rebounded almost immediately. The only harm done was to investors who had sleeping stops on securities, and who sold out above the 60 percent threshold set by regulators and exchanges that determined which trades were subsequently canceled. I feel bad for them.
But not as bad as I feel for all the investors who lost money in the ’70s, ’80s and ’90s paying higher commissions and wider spreads.
By all means, we need to reform market structure. Current suggestions to apply across-the-board single-security circuit breakers are spot-on. They will dramatically limit the likelihood of another flash crash.
But let’s not throw the baby out with the bath water. By and large, markets have become more efficient, fairer and generally better for the average investor over the past 20 years.
We just need to iron out the kinks.
Why 60 Percent?
BTW: While I agree that the regulators are doing a good job analyzing the flash crash, as Olly Ludwig pointed out in a blog last week, I feel they did a tremendous disservice to investors when they only reversed trades that took place 60 percent or more away from the last print at 2:40 p.m.
Virtually no one has reported this, but the NYSE Arca has its own internal process for potentially reversing what it calls “clearly erroneous trades.”
Generally speaking, when trades take place 10 percent or more away from the last consolidated sale, they are candidates for reversal. According to sources, the exchange was not allowed to apply this rule following the flash crash, as the SEC wanted all exchanges to follow a single rule.
Not a terrible idea, but why set that band at 6 percent?
Given the volatility, I could imagine bending the rules to allow a 20 percent deviation or something. But 60 percent? That was extraordinarily unfriendly to Main Street and effectively a gift to hedge funds and poaching algorithmic traders … exactly the guys and gals who got us into this mess in the first place.