Look at the ETF RSP yesterday. It's pretty much an S&P 500 index fund. When the S&P was down about 5% in the morning, RSP was down up to 40%. Didn't make any sense. Trading was getting halted every few minutes and buy orders were going unfilled.
An ETF like RSP won't always track the underlying index value exactly, especially in fast-moving markets.
Units of an ETF are just like any other share - an imbalance of sellers over buyers will drive the price down. In an orderly market, that usually isn't a problem - market makers will typically be there ready to absorb market orders and smooth out temporary imbalances, and "authorised participants" can create/redeem units/shares in the ETF if the market price starts to deviate from the NAV (net asset value - the market value of the underlying assets in the fund).
In a situation like we had yesterday morning, it's likely that market makers and authorised participants were staying out the market because it was moving too fast for them. In that sort of situation, if panic-sellers or forced sellers (e.g. due to margin calls) are placing market orders, an order book imbalance could easily develop, temporarily driving the price down to an unreasonable level before the market stabilises.
Sudden drops trigger trading halts, where trading is suspended for ~5 minutes. Trading in RSP was halted ten times between 9:30 and 10:30am yesterday - it didn't actually trade continuously for more than 34 seconds during that time (you can see this on the chart you linked to - there are only 11 points in the big V on the chart, then it reverts back to one point every minute from 10:30 onwards.
The same sort of thing happened during the Flash Crash in 2010.
It makes a ton of sense, actually. Intense fear drove large demands for liquidity thus spiking volatility. Thinly traded stocks and ETFs were hit harder than thick ones. ETFs, in particular, had additional demands placed on them as their underlyings were thrashed about at the open as many rushed to sell. The halts were from both limit up/down price band violations and volatility pauses and they did exactly what they were designed to do. In short: liquidity costs money and it isn't an infinite resource.
Yea, it's the speed of the drops. I saw more than a few weird looks from veteran stock analysts yesterday. The analysts who were older than 50 seemed to be the most honestly shocked, but tried to keep their composure. The look was like, 'I'd like to blame this on ETF's, but something else is going on?'
Throughout this thread, commenters are assuming that circuit breakers are helpful and useful. Yet no evidence in favor of that assumption is presented in the WSJ article. The CNN article quotes someone named "Dennis Dick" claiming they are useful without providing evidence.
Under economic theory, interference in markets prevents them from correcting prices and is therefore never a good thing. Certainly Milton Friedman [1] thought they were harmful rather than helpful.
Is anybody interested in sharing positive evidence that they are helpful? Helpful is presumably defined to mean they help prices stay as accurate as possible.
Your definition is inherently skewed. After all, what is an "accurate" price other than what the market is trading? Furthermore, why is an accurate price the overall goal? Perhaps other goals are more worthy, and would come at the expense of accuracy.
> Certainly Milton Friedman [1] thought they were harmful rather than helpful.
Ah yes, Milton Friedman, the man who was right about everything. Also never? Good god man, so what about market manipulation?
> Under economic theory, interference in markets prevents them from correcting prices and is therefore never a good thing.
Well if the market knew what it was fucking doing then it wouldn't need to correct prices now then would it? But the market does not know what it is doing, and when it shits itself, we have to come in and stop the world from imploding in a negative feedback loop.
For quite some time, the google workaround just brings me to the same truncated WSJ article, with an invite to subscribe or log in. The above link fails to get me in as well.
Is this working for some, but not for others? I've assumed that WSJ has just turned this method of entry off.
Yesterday was similar to the flash crash of 2010, except this time liquidity was much worse throughout the entire day, with a paralyzed market which was the direct result of countless distributed, isolated mini flash events, all of which precipitated the market's failure for the first 30 minutes of trading, illustrated by these stunning charts from Nanex: https://twitter.com/nanexllc
Of note in the WSJ article is the passage noting the extreme discrepancy in EFT prices and fair value as hedge funds sold off ETFs and market makers such as high speed traders and Wall Street firms refused to step in.
We did 13 billion shares yesterday, which is nearly 2x the 10 day average. The market was far from broken. In fact, I'd say it performed remarkably well.
I find it amusing that when the market is rapidly going up, everything is left alone. But when it's rapidly going down, or sporadically doing so, they halt trading and turn everything off for a while.
Does anyone else not see this as a clear sign the entire setup is broken and bogus? It's all a big joke.
what are you talking about? did you even read the article? it clearly says that anytime a stock goes UP OR DOWN 5 pct they halt trading on it for 5 minutes.
The need for these 'circuit breakers' really highlights the fact that Laissez-faire economic systems are in no way capable of keeping themselves stable.
>Laissez-faire economic systems are in no way capable of keeping themselves stable.
This is the point - Laissez-faire economic systems function well on their own, it just happens that humans prefer systems that are "stable". Hence, regulators try to limit the volatility of markets meet their stability preferences. Whether this is ultimately beneficial is an ongoing debate.
I would point out that in many cases enforcing artificial stability on markets can have negative outcomes. Recently, the +/-10% limits on daily stock price movements in China created situations where many stocks increased by 10% every day for over 100 days [0]. Such illusions of stability likely played a role in the recent bubble/crash in China. It could be said that attempts to regulate 'stability' into markets merely leads to a masking of tail risk, which can be very dangerous.
I think what bothers me most about your post is that you're right on the verge of pretending that regulating markets causes all of the things we don't like about markets. No. Markets do plenty of things we don't like. And yes, the way we chose to regulate them causes markets to do some other things we don't like, too. That's not a case for not regulating them, though.
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This is the point - smallpox functions well on its own, it just happens that humans prefer bodies that are "living." Hence, doctors try to limit the spread of the disease to meet their health preferences. Whether this is ultimately beneficial is an ongoing debate.
I would point out that in many cases enforcing artificial health on people can have negative outcomes. Recently, the Ebola virus in Africa killed several thousands. If the sick had been allowed to immediately die without care, the disease would not have spread so far. It could be said that attempts to regulate "living" into people merely leads to a masking of human frailty, which can be very dangerous.
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Maybe a slightly less offensive comparison on my part would have been wildfires. They do just fine without human intervention. And yes, maybe humans do intervene too much. But gee, we like our houses to not be on fire. That doesn't mean we let the fire just burn, though.
Reasoning by analogy is not a sound way to make an argument. In fact, reasoning by analogy is always wrong to some greater or lesser degree. It is much better to directly address an argument.
Markets are created by humans when humans exchange things. The current market price express the current knowledge of all participants about the value of some traded thing. This is a decentralized process that often involves millions of different people with skin-in-the-game.
The argument against government regulation follows from this: regulation distorts the market from an equilibrium price. If this is a temporary measure then regulation is only delaying the inevitable and you should let the market reach equilibrium sooner. If it is a permanent measure, then you have a situation where the market no longer reflects the current knowledge of all participants, and at this point you start to lose the core value of a market.
By the way: markets aren't analogous to smallpox and wildfires, and regulation is not analogous to doctors and firefighters. Although this is an interesting insight into your world-view ;)
Illustrating flaws in thinking by analogy is wonderful. People become too rigid in their faith in their current understanding, which is always wrong to some greater or lesser degree. By comparing one complex system to another complex system, we can quickly communicate volumes of information - such as a history of shared experiences. Darmok and Jalad at Tanagra.
Sorry if I was unclear, but I was making the point that a market is a system which can have temporary flaws. Such as a human can have smallpox, or an ecosystem can have a wildfire. I wasn't attempting to make the analogy between a market and smallpox or wildfires, I was attempting to make the analogy to a market fluctuation. Large difference. Perhaps the fault is mine, but I suspect it's more a case that you'd like to think poorly of people who think differently than you do.
Logic is wonderful, because it gives us the tools to have a conversation. Logic fails when two people have different assumptions. At best, it allows us to discover our different assumptions. You assume there is such a thing as an equilibrium price. Given that assumption, you can use logic to debate government regulation.
> A market is a system which can have temporary flaws
I guess this is where our assumptions diverge. I don't believe that a fluctuation in the market price can ever be considered a "flaw". Some people buy stocks and some people short stocks - a price increase is no better or worse than a price decrease. A market fluctuation is merely representative of a change in the opinion of the participants of a market. Market volatility merely demonstrates that there is a high degree of uncertainty amongst participants.
Hence, I don't believe there is any utility in trying to impede market fluctuations since this does nothing to change the root cause: the participants of the market haven't achieved a strong consensus.
The stock market runs on an exchange, which is implemented in software, instanced in hardware, managed by people, and subject to government oversight.
You may not have intended to, but you just asserted, among other things, that that system is perfect.
Please re-read my statement in this light, and try to see if you can find a way to agree with me:
"A market is a system which can have temporary flaws."
Okay, now that you're probably agreeing with me, but concluding that I'm being pedantic... Let me try to bring you back...
If the system itself causes a flaw, which affects prices.
So, if I want to relate to you, an IDEAL market behaves the way you're describing. Maybe no regulators needed.
An ACTUAL market behaves the way I'm describing. Regulators needed.
Once you agree with that, at least, maybe we can debate how BIG of an impact practical considerations have, and how large of a role regulators should have.
Markets cease to exist in unstable environment; "artificial" or not, stability is a precondition for existence of any social institution;I mean, come on, who wants to participate in unstable market?
The "market" is just a place where two parties can meet to exchange something at an agreed upon price. Stability has nothing to do with it.
If you get in a jam and essentially advertise to buyers, "I need to sell everything NOW, at any price!" you shouldn't be surprised if the buyer's offers are low. Why would I buy something now for $40, that I can get later for $20?
If the underlying thing is unstable, a market sitting on top of it will be unstable. If you try to force the market sitting on top to be stable by fancy jiggery-pokery, you've forcibly created a market that is no longer connected to what is below it, which now has all sorts of those arbitrage opportunities for the connected that people love to hate, and also dangerously hides further instability where you can't see it, because in a way it's conserved whether you like it or not.
You may want stability. You may even need stability. But neither of those two things means you get to have it. The universe and the world is fundamentally unstable.
You can look at what is happening in China right now in that way. They've forcibly created stability and reliability. Awesome, right? This worked great, until the absolutely and utterly inevitable black swan event occurred (to the point I have a hard time even calling it a black swan, since it was so predictable) because the conserved instability, instead of getting expressed in little ways on a day by day basis, is getting expressed as one big event.
Just because you fully dammed the river doesn't mean you've stopped the river from flowing, and it's time to build a dance platform in the middle of the old river bed and invite everyone to party all night long. It means you better run away from the entire river bed and everything even remotely near it before the dam catastrophically bursts and destroys everything.
You're looking not at a demonstration of why it's important to artificially stabilize markets... you're looking right at the consequences of doing so.
(In fact, the way that people then interpret the destruction of everything as a consequence of the dam just not being strong enough and we need to put politicians into power that will create an even BIGGER dam is an important element of understanding the ratchet of tyranny, and how what happened to the Soviet Union and Venezuela happened. It wasn't bad luck... it was misinterpreting overcontrol as too little control, and "correcting" in exactly the wrong direction. The failure of today becomes the excuse to grab yet more power, stomping on anyone in the way who objects, and grabbing centralized control even harder, which creates an even bigger disaster which requires even more centralized control... repeat until the society is too weak to even maintain a government anymore. And remember, if your comfortable Western-raised brain is objecting that this can't happen, it has happened, in this decade, to real countries that you can find on a globe. It is not a thing of myth and it is not even a thing of the past. It is a path we humans seem congenitally prone to.)
Underlying markets _are never stable_. The main stabilizing force in the world are institutions of power and violence, such as army (especially American), police, jails etc. Markets already rely heavily on governments for their existence. You got Black Swan completely wrong, if you think that Taleb is advocating for laissez-faire, he is actually big fan of slow and dull, tightly controlled systems ("antifragile").
He is literally advocating the opposite of what you said. Governments are centralized and fragile (don't like volatility) hence their propensity to regulate volatility. He directly blames (large) government for the GFC - see 4:40 in the video.
Antifragility is not liking volatility; it is dislike but acceptance of it.
This is what he said:
“(4) Build in redundancy and overcompensation
“Redundancy in systems is a key to antifragility. As Taleb suggests, nature loves to over-insure itself, whether in the case of providing each of us with two kidneys or excess capacity in our neural system or arterial apparatus. Overcompensation is a form of redundancy and it can help systems to opportunistically respond to unanticipated events. What seems like inefficiency or wasted resources like extra cash in the bank or stockpiles of food can actually prove to be enormously helpful, not just to survive unexpected stress, but to provide the resources required to address windows of opportunity that often arise in times of turmoil. This perspective helps to put into context the praise of inefficiency in Bill Janeway’s important new book, Doing Capitalism in the Innovation Economy."
Well, to build in redundancy you need market manipulation (FDIC for example), otherwise markets will tend to overfitness. If you are claiming that "antifragility" = laissez-faire you are completely wrong; who will enforce the redundancy?
Who enforced the redundancy of humans possessing two kidneys? If you are a creationist, then I guess we have different starting assumptions.
Assuming that you aren't, then you would understand that redundancy in humans literally evolved from randomness and volatility. Evolution is a hill climbing algorithm - the organisms that survive the best reproduce more and become more prevalent. For me, nature is perfectly laissez-faire, there are no circuit breakers in nature, there is no enforced stability.
Except that this crash saw ETFs - which are basically just a way of holding a basket of different investments - plummet spectacularly even though the underlying assets they were created to hold barely moved. The underlying thing was stable, the problem was the market on top of it.
That sort of behaviour seems more correctly described as exploiting the market's instability rather than participating in the market. If you extract wealth without improving the market itself how are you a participant?
This sort of financial behaviour seems more to me like watching a football match you've bet on and shooting any player that might influence the result away from your preference then claiming you were a player in the game.
So, great if you want to extract money from others productivity but not so great for the market as an economic [in the base meaning of the word] structure.
> great if you want to extract money other's productivity but not so great for the market as an economic structure
No this is not correct. Options are derivatives that are traded on a secondary market. When you buy an option (or two options - call and put - in the case of a butterfly spread) you are buying from someone who is selling the option(s). Hence you are not "extracting" money from others, you are engaging in a voluntary bet with another person.
Derivatives are very important tools in a modern economy. They are frequently used by businesses and individuals to hedge their exposure to volatility and uncertainty. For instance, if you are close to retirement and still own some stocks, you could hedge your downside risk by purchasing put options. This behaviour has no negative effect on the primary market.
> If you extract wealth without improving the market itself how are you a participant?
You are a participant in a secondary market, not the primary market. You only gain wealth if you bet correctly - you still have risk like any other traded asset.
Markets continue to exist regardless of stability.
Whether people prefer stable or unstable has nothing to do with whether or not said market exists.
There is never a point in which there is perfect stability, or a total lack of instability, therefore there can never be a market - that's the logical conclusion of your premise. It disproves your claim.
Who defines how much instability must exist, such that a market ceases to exist? The completely subjective nature of it also proves it's wrong.
You mean like the system where the US government printed money like crazy during the 1990s - 2000s and had official policy encouraging folks to buy homes who could not afford them? Or the central economic planning and corruption at every level in China, resulting in unneeded cities that sit nearly entirely empty? These two correlate ~ cheap money in the US (artificially low interest rates) got transferred to China en mass, fulling growth there, much of which is misdirected due to central planning. So yes, let's apply more central planning to the effects instead of unravel the cause.
Circuit breakers are only needed to help people who are the victims of bucket shop scams (a deal where the victim loses money based on the price of a trade to which they were not a party). There's no other reason to care about what price people make trades at or if they make deals at other-than-market prices. In the absence of bucket shops, the answer to "these prices are bad, I don't want to sell at a bad price" is "then don't".
Circuit breakers are a symbol of a massive regulatory failure, mitigating and legitimizing a fraud instead of prosecuting it.
I'm curious how you reached this conclusion after (presumably) reading OP's article about the rather tenuous stability of our decidedly not-laissez-faire stock market.
http://finance.yahoo.com/echarts?s=RSP+Interactive#{%22range...