When the stock market fell 7% on the open this morning, circuit breakers kicked in to halt market trading for 15 minutes. If the S&P 500 falls 13%, the market is halted again, and if it falls 20%, the market closes — and in this case, such a drop would hail the end of the bull market that began in March 2009. These levels aren’t so far away, but advisors should understand how and why they work to help allay client fears.
“The market circuit breakers are designed to slow trading down for a few minutes, give investors the ability to understand what’s happening in the market, consume the information and make decisions based on market conditions,” New York Stock Exchange President Stacey Cunningham told CNBC. “This is operating as it’s supposed to.”
In a tweet, she added that “these precautionary systems have a long history, and we continue to update them as markets evolve. Our goal is market resiliency during times of stress.”
Although stock market circuit breakers were put in place after the Oct. 19, 1987, stock market crash known as Black Monday, it wasn’t until after the flash crash on May 6, 2010, that the Securities and Exchange Commission updated them to apply to individual stocks, which have breakers on the up and down side. ETFs are treated as individual securities. Broad market indexes’ circuit breakers apply only on the downside. After 3:25 pm Eastern time, trading will not be halted if the market goes beyond 7%.
Today’s market halt during the price plunge at the open was an example of circuit breakers at work. The market drop was attributed to the growing outbreak of the coronavirus, but also to a 30% plunge in the oil markets, largely due to OPEC’s failure to set production levels and Saudi Arabia’s standoff with Russia, the third largest oil producer in the world (after the United States and Saudi Arabia).
Commodity futures markets have their own form of circuit breakers, called price limits. On Friday, the CME Group halted trading in the Ultra U.S. Treasury bond futures four times during the day. The Ultra contract is similar to U.S. Treasury bonds, but with a narrower basket of deliverables, with 25 years of remaining term to maturity.
Commodity futures have various price limits. Crude oil futures and other energy markets have dynamic circuit breakers using a one-hour lookback. If the market moves up or down 7%, in that time, the market is halted two minutes, a CME spokesperson said.
Stock index futures price limits mirror those of the New York Stock Exchange.
Some traders believe that these measures, originally put in place after the 1987 stock market crash to cool off a panic, disrupt more than help. With the market halting shortly after the open on Monday, some traders cried foul, stating it interrupted a rally.
James J. Angel, an associate professor at Georgetown University and a chartered financial analyst, noted on Twitter that his comment letter to the Securities and Exchange Commission in 2016 still stands: that limit up/limit down halts are “messy” on the reopening, and perhaps a better idea would be gradually “widening bands instead of a market halt.” He also stated that bands on the open should be widened to 10%.
— Related on ThinkAdvisor: