There is no evidence that so called ‘circuit breakers’ can prevent a flash crash in the market, and they may even make things worse.
Under major reforms to be unveiled to the stock market, brokers will be required to install software that acts as a ‘kill switch’ if there is a threat to the market from computer trading systems, and prevent a ‘flash crash’, such as the one that wiped $US1 trillion off Wall Street in minutes last year.
There is considerable evidence that the circuit breakers reduce trading quality, and indeed they put you in the line of fire.
Alas, all regulators follow the same pattern in the face of a threat of a flash crash. Quite simply, a circuit breaker or a ‘kill switch’ simply makes all the markets close at the same time. What happens then is that all the cash dries up – we saw this when the New York exchange halted trading – and waits for the markets to reopen; it’s just a question of postponing what will naturally happen.
High speed automatic trading is now very popular, with one in five share transactions in Australia traded by computers using algorithms to calculate if a deal will make a profit. With so many computers trading, they are now competing to trade faster than other computers, and beat them to a better deal.
I feel regulators haven’t grasped the implications of halting trading if there is a crash, and just make a knee-jerk announcement that looks good, but achieves little.
Security regulators make decisions based on their perceived authority, not on the available evidence. What we need is evidence from markets that stay open. Alas most exchanges around the world, including in Australia, will follow the lead of the SEC who try to halt all the markets. It is very hard to get evidence in the first instance of what happens for leading markets when they do stay open if prices are falling sharply.
With a proliferation of high-speed trading expected with the launch of the alternative stock market Chi-X in Australia at the end of the month, I am dismayed to see regulators trying to control high-speed trading in this way.
There is no evidence that circuit breakers are good for trading, around the world or in Australia.
Professor Michael Aitken is the Chair of Capital Market Technologies at the Australian School of Business