The SEC announced a proposal Tuesday backed by the major U.S. exchanges that limits stock price movements.
The plan, known as limit-up/limit-down, prevents prices from moving beyond specified bands based on a stock's average level during the previous five minutes. It was a modification to halting stock trading to limit price volatility, which the exchanges thought did more harm that good.
Advisers to the Securities and Exchange Commission and the Commodity Futures Trading Commission on Feb. 18 recommended adopting the technique in lieu of immediately halting shares.
Exchanges implemented single-stock circuit breakers after the 20-minute rout on May 6 erased $862 billion from the value of U.S. shares before prices rebounded. The current system halts Standard & Poor's 500 index and Russell 1000 index companies and more than 300 exchange-traded funds for five minutes whenever they rise or fall at least 10% in five minutes. Exchanges and the Financial Industry Regulatory Authority want price bands to replace this mechanism.
“This addresses issues that occurred related to May 6 in terms of the deviation of prices and fast price movements,” said Joseph Marinaro, chief business development and strategy officer at New York-based Surge Trading Group, an electronic market maker in equities. “It provides more stability to retail investors.”
For companies already covered by the circuit breakers adopted last year, trades wouldn't be able to occur 5% higher or lower than the average price over the prior five minutes, the SEC said. For all other securities, the band would be set at 10%. Wider collars would apply for shares trading below $1. The thresholds would be doubled in the minutes surrounding the open and close of U.S. exchanges.
If a stock price rises or falls to the threshold and trades are “unable to occur within the price band for more than 15 seconds,” a five-minute pause will be imposed, according to the SEC statement. The halt will give investors time to respond to “fundamental price moves” driven by news about companies, the SEC said.
The proposal would affect trading on all exchanges including those run by NYSE Euronext, Nasdaq OMX Group, BATS Global Markets and Direct Edge Holdings, as well as private venues such as dark pools and brokerages that execute orders within their own walls.
“The cavalry has arrived,” said George Hessler, president and CEO of Stock USA Execution Services, an electronic brokerage firm that trades between 3 billion and 4 billion shares a month. “We've been waiting for this. This should be a good step in improving market structure in the equity marketplace.”
The initiative should eliminate problems involving “the runaway market order or mistakes with a limit order” that triggered circuit breakers in the past, Mr. Hessler said. Market orders are requests to buy or sell shares immediately regardless of the price. Limit orders are trade requests that specify the highest or lowest price the investor will accept.
The five-minute halt imposed by the current circuit breakers “has been particularly problematic in a number of situations in which a single erroneous trade triggered the pause,” the Feb. 18 report from the SEC-CFTC advisers said.
“Upgrading our trading parameters will help our markets retain the confidence of investors and companies,” SEC Chairwoman Mary L. Schapiro said in Tuesday's announcement. “We were focused on improving the structure of our markets before weaknesses were exposed on May 6, and we will continue to be focused on market structure going forward.”