Does SGX really need circuit breakers?
After resisting the idea of having circuit breakers for years, the Singapore Exchange (SGX) has now indicated that it will soon introduce these artificial stops for trading in times of high volatility. The exchange’s decision is likely based on the pervasiveness of high-frequency trading (HFT) in everyday market life and the rising public concern (and belief) that HFT could cause, or at least contribute greatly towards, a market crash. Having circuit breakers, it is believed, would afford some protection for small investors.
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By R SIVANITHY
25 April 2011
After resisting the idea of having circuit breakers for years, the Singapore Exchange (SGX) has now indicated that it will soon introduce these artificial stops for trading in times of high volatility. The exchange’s decision is likely based on the pervasiveness of high-frequency trading (HFT) in everyday market life and the rising public concern (and belief) that HFT could cause, or at least contribute greatly towards, a market crash. Having circuit breakers, it is believed, would afford some protection for small investors.
We’d have to say we’re sceptical. The aim of having breakers - to draw heavily from US conventional circuit breaker wisdom - is supposedly to reduce volatility and promote investor confidence, because forcing a pause in trading at times of maximum turbulence should enable investors to digest incoming information and make better choices. Which sounds fine in theory, but presents all sorts of difficulties in practice.
First, it’s worth noting that HFT has been around a lot longer than most people know and yet developed markets such as Australia and Hong Kong don’t have - or don’t see the need for - any circuit breakers.
Second, you’d have to wonder why circuit breakers in the US, where the idea first originated, are biased towards one direction only, namely the downside, and why there are no provisions for a break in trading when prices are rising too fast. Since volatility doesn’t come about only when markets fall, shouldn’t halting trading apply equally to the upside as well, if curbing volatility is the goal?
Or to look at it from a slightly different angle, doesn’t the presence of circuit breakers as a form of implicit downside insurance only serve to encourage excessive risk-taking?
If yes, then markets that introduce these ‘time-outs’ are simply embarking on a never-ending cycle of encouraging more risk-taking which leads to the inflation of bigger bubbles, which in turn results in bigger busts that create greater volatility and ultimately, call for more circuit breakers to try and curb the volatility.
Third, studies into the effectiveness of circuit breakers generally show they offer few or no benefits. For instance, knowing that trading could be halted soon because the main index has already moved a certain amount could lead investors to accelerate their selling, thus adding to the chances of a crash.
It’s also unproven that a market ‘time-out’ really results in investors calmly assimilating incoming information or whether it only increases anxiety levels as traders wait for trading to resume.
For example, in ‘Volume, Volatility and NYSE Trading Halts’ which appeared in the Journal of Finance’s March 1994 issue, researchers found that trading halts did not reduce volatility but instead increased it because the period immediately after a halt was characterised by heightened volume and volatility.
This result was true for different types of halts, different types of news events and different times of the day. The authors concluded that circuit breakers do not facilitate information transmission and that trading halts do not calm markets.
However, SGX appears to have made up its mind to follow the herd. So assuming that a market as small as Singapore’s really needs nerve-calming measures when sentiment is running at its extremes and prices are swinging wildly, what should SGX be mindful of when designing its circuit breakers?
First and most obvious, let’s hope it applies its curbs in a directionally neutral manner and does not target only the downside.
Second, let’s also hope the exchange can come up with less-confusing measures than those in place on Wall Street where regulators have surely gone overboard in trying to ensure no crash occurs.
For the second quarter of 2011, if the Dow drops 1,200 points before 2pm, trading is halted for one hour; if the fall occurs between 2-2.30pm, the halt is 30 minutes; and if it’s after 2.30pm, there is no halt.
If the Dow drops 2,400 points before 1pm there is a two-hour halt; if this occurs between 1-2pm there is a one-hour halt; and if it’s after 2pm, the market is closed. If the Dow plunges 3,600 points, the market is closed for the day regardless of time.
If this isn’t confusing enough, all these figures are recalculated at the end of each quarter. You have to wonder - is it really worth the trouble?