On Thursday Canada’s investment industry regulator, IIROC, proposed new safety measures intended to prevent future flash crashes like the one that happened on May 6.
Existing “circuit breakers” halt trading when the entire market rises or falls extremely quickly within a short period of time, but trading in individual stocks must be reviewed manually. This new proposal would allow trading to automatically be halted for a five minute period on any stock that appears to be subject to a “flash trading” scenario.
The plan is to prevent the extreme investor losses we saw in May, when some stocks lost up to 99% of their value in minutes.
IIROC has invited public comments on the proposal during the next 60 days. Read the press release here.
Reuters is reporting that no one knows exactly what caused last week’s crazy market gyrations, although there are plenty of weird theories to go around. Personally I kinda like the space alien theory, although the fat finger theory has a certain lyrical quality too.
Approximately 10,000 trades were cancelled, but many traders were left on the hook for trades that were considered within bounds. The complaints from those left out in the cold will probably continue for some time. It appears a large number of people were caught by automated stop-loss orders that sold their positions out at or near the bottom. According to former SEC Commissioner Roberta Kemel, there may be little recourse for those investors. Lawyers say that claimants would have to show “gross negligence” in order to have any kind of case.
SEC Chairman Mary Schapiro told the House Committee on Financial Services that ETFs were particularly hard hit by the chaos for reasons that “are still unclear”. More than 25 percent of all such funds lost at least half their value. One ETF sponsor told the SEC that 14 of its funds briefly traded for less than 15 cents a share.
This is the type of circumstance which highlights the downside of index tracking passive management. It also exacerbates the issues surrounding leveraged investments and the narrow focus of some industry specific ETFs.
I think ETFs have been mischaracterized as a buy and hold investment, when in fact they were originally designed for active traders who wished to track an individual index or basket of stocks. They were always intended to be sold if the markets trended downward.
And heaven help anyone who was involved in any leveraged products, and didn’t understand what they were getting themselves into. I don’t think the industry has done a very good job of explaining these products to the average retail investor, and yet everywhere you see advisors pushing them as a low cost substitute for mutual funds and recommending ETFs for inclusion in buy and hold RRSP accounts. Not good.
Today’s lesson – a little knowledge can be an expensive thing.