A 30-year-old piece of market infrastructure has been thrust back into the spotlight after a recent rout in U.S. equities triggered the mechanism for the first time in years.
Following a weekend in which the spread of the novel coronavirus accelerated and Saudi Arabia and Russia kicked off an oil price war, the S&P 500 plunged March 9 when U.S. stocks opened for trading. The 7% drop that happened just minutes into the trading day set off what is known as a circuit breaker, prompting a 15-minute halt designed to provide investors with a chance to play catch-up before the market resumed trading.
The S&P 500 ended the day down 7.8%, marking the worst trading session for U.S. stocks since the 2008 financial crisis. But stocks had slightly bounced back after the forced stoppage ended around 9:49 a.m. ET, sending a signal to Wall Street that the breaker did its job.
"Market-wide circuit breakers enforce a trading pause so that investors have time to absorb information, better understand what's happening in the market and make decisions accordingly," New York Stock Exchange President Stacey Cunningham tweeted in the afternoon of March 9. "The halt in trading this morning means that the market-wide circuit breakers functioned exactly as designed."
Circuit breakers were first introduced in the U.S. stock market after the 1987 market crash now known as Black Monday, which caused stocks to enter an unguarded free-fall. The last time the breakers went off before March 9 was in 1997, according to a NYSE spokesperson.
Under the latest regulations set in the aftermath of the 2010 flash crash, there are three marketwide circuit breakers in addition to limits on how much individual securities can fluctuate in a single day before prompting a halt.
After the 7% threshold that prompts a 15-minute marketwide trading delay is hit, stock exchanges are required to once again stop trading if the S&P 500 falls to 13% before 3:25 p.m. ET. The U.S. stock exchanges that list equity securities, such as those run by NYSE, Nasdaq Inc. and Cboe Global Markets Inc., would then be required to shut down trading for the day if the S&P 500 drops 20%.
"It lets everyone take a breath," said Dave Lauer, co-founder and CEO of Urvin AI, an artificial intelligence company that also offers analytical tools for market structure issues, in an interview. "[Trading] looked smooth to me."
Marketwide circuit breakers offer traders an opportunity to reassess their systems and pending orders as well, according to Security Traders Association President and CEO Jim Toes, who equated it to a pilot taking a plane off of autopilot to make sure everything is working as intended. It was not just the broad-market trip wires that helped stabilize trading early in the day March 9, either, Toes said in an interview.
Throughout any given trading day, individual securities are dealt within constantly updated price bands in a construct known as limit up/limit down. That model came under fire following the Aug. 24, 2015, flash crash, when only about half of the stocks in the S&P 500 opened on time because of the tight range of prices they were allowed to trade within.
But those bands have been changed in the years since to allow for more flexibility during the open and to avoid incidents like the 2015 flash crash, Toes said.
"If August 24th would have occurred yesterday, I don't want to think of what would have happened," Toes said.
The rush of volatility in recent weeks may not be over, though.
Around the world, the coronavirus outbreak is accelerating. State and federal officials in the U.S. have been grappling with how to address the public health crisis, while Wall Street is being directly hit with new cases at a gradually increasing rate.
"Volatility is highly persistent," said Chester Spatt, a finance professor at Carnegie Mellon University who was the SEC's chief economist from 2004 to 2007, in an interview. "Whether the market is up or down, we know there's going to be a lot of volatility for a while."