In hopes of preventing another repeat of this month's market crash -- when the Dow fell nearly 1,000 points -- the Securities and Exchange Commission is proposing new rules. The SEC is going to start its reforms with individual stock fluctuations and then move on to whole exchanges. It is expected to unveil the new rules for exchanges soon, but it hopes a new circuit-breaker mechanism will stop trading in individual stocks that experience large fluctuations over a short period. Trading in any one of the 500 biggest stocks will be programmed to stop if it experiences a 10 percent change in price over a five-minute period.
What's in the new rules?
The basic idea in the new rules is what's called a circuit breaker. If the price of certain stocks moves -- down or up -- more than 10 percent in a five-minute period, it triggers the circuit breaker. And trading on that stock stops.
Mary Schapiro, chair of the SEC, said about the new rules, "I think those will be very important circuit breakers, or speed bumps, to help the markets adjust to the volatility we've seen."
Right now, the new rules will only apply to stocks that are part of the S&P 500. And they're meant to improve on the circuit breakers that are already in place.
Why didn't circuit breakers work before?
The problem with the circuit breakers in place right now is that they're set up as if the stock market were a single entity. And actually there are lots of exchanges -- each with different rules for setting off the circuit breakers. During the flash crash, markets didn't have uniform circuit breakers. Each exchange had its own rules. Manual traders had one set of rules and the electronic exchanges had another. And the Dow didn't fall quite far enough to trigger those existing circuit breakers. Basically, the circuit breakers in place weren't sensitive enough to go off on May 6 when the markets went so crazy.
When do these rules take effect?
There's a short comment period. But it seems like most people think the new rules are a good idea, so the rules should go into effect by mid-June. After that, there's a six-month trial, to see how well they work. And during that time, regulators will also look at other questions, like whether to make the existing circuit breakers more responsive. And how trades can be cancelled after something like this happens.
How much good can these circuit breakers really do? Ken Kuttner, a professor at Williams College, asks: "How do you design these circuit breakers in such a way that they have the desired effect of reducing volatility rather than, by stopping trading, making prices fall even further?"