Sunday, May 9, 2010

What Really Happened When Stocks Plunged

NEW YORK (CNN) -- New York Stock Exchange efforts to stabilize Thursday's stock market had the opposite effect, triggering a momentary market collapse.
It wasn't a goof. It wasn't human error. Rather, it was an instant that displayed the hazard of new markets that handle billions of dollars' worth of trades each day.
During yesterday's fast-moving midday market, NYSE specialists -- who oversee trading in individual stocks -- used their authority to call a momentary time out. The idea was to bring together buyers and sellers, and get their prices more in line with each other.
It happened in five Dow stocks, including 3M (MMM, Fortune 500) and Procter & Gamble (PG, Fortune 500), according to the NYSE, and in a good number of the listed stocks. The NYSE did not have a tally of exactly how many.
Years ago, when the NYSE dominated trading, such "time-outs" worked well at stabilizing stock prices.
But today, the NYSE accounts for only about 25% of the volume in its listed stocks. Much of the rest comes from computerized markets run by private companies -- and some of those systems did not take a time out yesterday.
"The rest of the markets are free to trade around us," said NYSE CEO Duncan Neiderauer, "and that's what they did."
So, as the NYSE paused for a minute or two at about 2:40 p.m. ET, the off-exchange computers kept searching to execute trades. They hit the best bids still standing, which in many cases were far below the prior price.
And in some cases, the off-exchange computers found no bids at all. When that happens, market-making computers see a zero bid, then offer a penny higher to capture the trade and collect a commission -- hence the trades of just one cent for several stocks, including Accenture (ACN), Boston Beer (SAM), Exelon (EXC, Fortune 500).
"Computers are looking for the best bids. The real best bids shut themselves down," one trader told CNNMoney.com.
"You had penny prints. The bid was zero. The algorithms were designed to penny the bids," said another trader.
The NYSE argues Thursday's sudden plunge shows its model is best suited to maximize market stability.
"Yesterday's experience clearly demonstrates the value of retaining an element of human judgment in the market," said NYSE spokesperson Ray Pellecchia.
But the role of human judgment has been rapidly diminishing in the securities marketplace, placing individual investors at risk of such an instant market meltdown happening again. To top of page