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Circuit-breakers were supposed to stop ‘flash crashes’ in shares, but they are failing to do their job. That could have worrying implications for the stock market, says new research.

Regulators have been fretting over the 'flash crash' phenomena ever since May 6 2010 when confusion in the US markets caused the Dow Jones Industrial Average index to plummet 1,000 basis points in around 20 minutes.

The event sparked months of industry soul-searching regarding the structure and speed of the US and European equities trading markets, calling into question the emergence of super high-speed trading practices that have become an integral part of the modern markets.

Stock-specific circuit-breakers introduced in US markets in June were supposed to stop all this. But research by French brokerage CA Cheuvreux highlights four mini crashes in specific stocks since June, some with even sharper falls than on May 6.

On September 27, for example, Progress Energy lost 90% of its share price in less than a tenth of a second. US stock market NYSE correctly triggered its circuit-breaker, but Nasdaq, which also trades Progress Energy, did not and had to void the trades that occurred during the stock's freefall.

What this suggests, according to CA Cheuvreux, is that circuit-breakers are not the answer to preventing erratic and potentially damaging stock price behaviour. Given the speed at which stocks can rise and fall, there remains a risk, as in the case of Progress Energy, that an exchange's circuit-breaker cannot respond with enough speed.

What's more, says CA Cheuvreux, if one exchange is not able to trigger its circuit-breakers on what appears to be a troubled stock, the risk of the stock entering into a fully fledged crash on that exchange increases.

The report also shows that mini flash crashes can work both ways by pushing the stock upwards just as suddenly as it can fall: on June 16, for example, the price of Washington Post stock jumped off the scale within the blink of an eye.

So If circuit-breakers cannot be relied upon to prevent mini crashes, what is the answer? According to CA Cheuvreux, the solution is to slow down. “The incidents of mini-flash crashes show that, with respect to the global dynamic of the markets, something continues to be wrong," says Charles Lehalle, head of Quantitative Research at CA Cheuvreux.

"We believe that if we want to do something to address this, the dynamic of the price formation process must change. Strange though it may sound, we believe that some friction needs to be introduced into the market. This would help mitigate such erratic stock price moves.”

That an equities broker has come out and argued in favour of slowing down the markets is remarkable given that the European trading community is currently embroiled in a public battle with European regulators who desire, much to the horror of many trading chiefs, to do just this.

That though appears to be exactly what CA Cheuvreux wants. That suggests that the regulatory fears that super-fast trading can distort the orderly functioning of the markets may not be as overblown as some traders would have us believe.