SEC Moves to Test New Circuit Breakers

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In order to reduce the chance of another large dip in US stocks, the SEC will be testing new rules to govern trading first on S&P 500 stocks.  The new rules, slated to go in place until December 10, will suspend trading in any S&P500 stock that rises or falls more than 10% in any five minute period.  After the 10% dip, the individual stock will cease trading for five minutes.

Circuit Breaker Goals

The SEC hopes that by creating circuit breakers, the stock markets will react more rationally during sell-offs.  By pausing for five minutes after a 10% plunge, traders will be forced to sit on positions, without an ability to sell.

In addition, the circuit breakers prevent runaway losses due to stop loss market orders.  Contrary to popular belief, stop loss orders, which investors set to exit a position when it falls below a certain price, are actually market orders, not limit orders.  As we saw in the 1000 point plunge in the Dow a few weeks ago, stop loss orders can send the market into freefall, as more stocks come up for sale as prices plunge.  The rules would also restrict upward movements of greater than 10%.

How Will the Circuit Breakers Work?

The circuit breaker system will only work between 9:45 and 3:35, allowing for large changes in price at open to reflect overnight developments, and the system will cease before market close to not restrict investors from cashing out of a position before the day ends.  This is important for day traders and swing traders, who usually rely on leverage and are charged carry fees on the margin if positions are held overnight.

Rules Expansion

The SEC will look to expand the rules to more individual stocks and ETFs “as soon as practical,” hoping to curb rapid selling or buying sprees spawned by electronic trading on all stocks.

In addition, although not mentioned in the recent release, analysts expect a similar macro circuit breaker to be applied to general indexes.  Whether or not the rules will stick is still up for debate.  A ten-day session will soon be held to discuss the effects of the circuit breaker system on the stock markets.

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