Cisco Trips Circuit Breaker: The Details
Cisco is the latest stock halted for tripping circuit breaker; another failure for our creaky trading system.
Cisco has joined
- the Washington Post,
- Anadarko Petroleum and
- Genzyme, all of which have been halted recently under new circuit breaker rules adopted by the SEC. The rule requires a 5-minute halt in trading whenever a stock trades above or below 10 percent in a 5-minute period.
Here's what happened: at 10:41:33, Cisco was trading at roughly $23.38. At that moment, there were 8 trades of 100 shares that traded on the Amex, which had just started trading in Nasdaq-listed stocks a couple weeks before.
Here is the price progression of those 8 trades trades that printed on the Amex, each 100 shares: $23.67, $24.13, $24.16, $24.51, $24.59, $25.37, $25.56, and $26.00.
Once the stock printed at $26, it triggered the 10 percent rule and was halted.
Remember, these trades happened essentially at the same moment.
How could this happen? How can a liquid stock like Cisco go from $23.38 to $26.00 in a few milliseconds?
It can't be because there is no one willing to sell them Cisco stock on another venue.
Don't go blaming the Amex, or the NYSE, or the Nasdaq. The likely culprit is the way our trading system is structured.
Simply put: the market has fragmented into multiple pools of liquidity, which in reality are neither deep nor liquid.
Here is what likely happened: a market order (an order to buy at whatever the prevailing price) of uncertain size was placed to buy Cisco on the Amex. There was obviously very little liquidity (offers to sell) on that venue, because the print on the Amex was $23.67, well above the then-prevailing price of $23.37-$23.38.
But wait: shouldn't the computers at the AmEx then have routed the buy order to the next venue (Arca, Nasdaq, BATS, Direct Edge) that had a better price?
The answer is yes, but the prevailing rules often prevent the best bid and offer from being executed.
Under prevailing rules, venues are required to go to other venues but only sweep the "top of book." In other words, the Amex computers would have gone to another venue, where their only requirement was to take the ONE best offer...say it was for 100 shares at $24.17. That's all: it then can move on to another venue, take the "top of the book" there...say,100 shares at $24.51...then move on.
If it ends up back at the Amex and still hasn't filled the order, it keeps hunting at the Amex until it finds an offer...in this case, $26.
But wait, you say...this is absurd! Why can't it hunt for additional liquidity in ANY venue...surely there were offers at the Nasdaq to sell at $23.38.
I'm certain there was...and you are right, it is absurd. The reason this happens is that exchanges — all of them — want customers to stay in their exchange. They offer money — rebates — for them to add liquidity.
This would not happen if there was a consolidated order book. In this scenario, there could be 50 exchanges, but if they all were required to access the complete book of each exchange, you would not have absurd situations like Cisco today.
The NYSE has said the trades in Cisco will stand. Let's hope the SEC order handling rules do not.
Trust me, this will change...the SEC issued a Concept Release in January where problems with market orders and market structure were discussed and identified.
It went nowhere, but the Flash Crash on May 6 has revised interest in this issue.
A joint SEC-CFTC Committee is currently conducting an investigation into the causes of that Flash Crash. There is no timetable for a final release of the report yet, but it is all but certain that the creaky market structure that has become our trading system will be high on the list of causitive factors.
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