The measure will help prevent sudden stock market plunges caused by unusual trading activity in response to the flash crash on May 6, when the Dow Jones Industrial Average dropped almost 1,000 points within 30 minutes.
The brief crash was unusual and unsettling, especially since no adverse economic news triggered the fall.
The regulators have not concluded on a reason for May 6’s extreme market volatility, but the SEC said a variety of factors may have contributed to the jolt—including stop loss measures by numerous institutional investors, which means that the brokerage would automatically sell shares when it hit a certain low-point.
The SEC has been testing a pilot program since mid-June, which would halt trading on a particular stock that experiences severe and unexpected price movement.
Last Friday, the SEC announced that the circuit breaker would also apply to all Russell 1000 stocks, as well as exchange-traded funds (ETFs). Russell 1000 is an index that tracks performance of U.S. medium-sized businesses.
“These circuit breakers and this more objective guidance on breaking erroneous trades will help our markets retain the confidence of investors and companies,” said SEC Chairman Mary L. Schapiro in a statement.
Cracking Down on High-Frequency Traders
In addition to circuit breakers, the SEC may impose buy and sell restrictions on so-called high-frequency traders which today makes up more than half of all trading volume on the major stock exchanges.
High-frequency trading is sometimes called quantitative trading and occurs when a trading platform would automatically purchase or sell a huge block of stocks to take advantage of small market inconsistencies.
In a speech before the Economic Club of New York last week, Shapiro cited comments from many investors and brokerage firms that market volatility has forced many stock market investors to pull out of the market.
“Retail broker-dealers have told us that their customers—individual investors—have pulled back from participating in the equity markets since May 6,” Schapiro noted. “Indeed, according to mutual fund data, every single week since May 6 has seen an outflow of funds from equity mutual funds.”
She noted that high-frequency trading—due to its ability to affect broader stock market movements—is an area of concern for the SEC, and many firms that employ such strategies are not regulated closely.
“In fact, many very active liquidity providing firms are not registered as market makers, and some active firms are not even registered as broker-dealers and thereby fall entirely outside the regime for regulated entities,” she said.
“Professional trading firms with the best access to the markets (and therefore the greatest capacity to affect trading for good or for ill) should be subject to obligations to trade in ways that support the stability and fairness of the markets.”
The SEC will release a study on such trading activity in the near future to propose solutions.
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