Wall Street & Technology is part of the Informa Tech Division of Informa PLC

This site is operated by a business or businesses owned by Informa PLC and all copyright resides with them. Informa PLC's registered office is 5 Howick Place, London SW1P 1WG. Registered in England and Wales. Number 8860726.

Trading Technology

11:49 AM
Anthony Becker, SunGard’s Valdi Trading Compliance
Anthony Becker, SunGard’s Valdi Trading Compliance
Commentary
50%
50%

Limit Up-Limit Down: Where’s the Limit?

It seems like the Limit Up-Limit Down rule is a blanket oversight that fails to tackle the real issue around extraordinary market volatility, the rise of high frequency trading and rogue algorithms.

On April 8, 2013, the new Securities and Exchange Commission (SEC) rule Limit Up-Limit Down, aka Rule 608, will go into effect in the attempt to lessen volatility in the equities market. Limit Up-Limit Down was passed on May 31, 2012 to “address extraordinary market volatility market wide.” At the time of the ruling, the Single Stock Circuit Breaker rule was in place to address market volatility, but was not consistent across the market. Limit Up-Limit Down will eventually replace the Single Stock Circuit Breaker in its entirety as it is rolled out in two phases over 2013 with the complete roll-out expected to be complete by September 2013.

To understand why this new rule has come about, one needs look no further than the events of May 6, 2010, known as the “Flash Crash.” During the Flash Crash, the market nose-dived at record rates in a very short time; within only 20 minutes, the market had dropped nearly 1000 points. Almost as fast, the market gained back nearly 600 points. This type of incident is ripe for conjecture and philanthropic thought about how to stop another Flash Crash event from taking place again. Unfortunately, the ‘why’ is generally overlooked, as seems to be the case again today, where once again firms are sent scurrying to comply with a new regulation.

As technology has advanced, the markets have relied more and more on electronic trading, which coincidentally has led to some of the most significant market events in recent times. This has put an unnecessary burden on a vast majority of firms, who, in an already fragmented market with withering profit margins, now must spend more on compliance. The costs of running a business are becoming astronomical and firms are feeling that burden.

Now it seems obvious that the Flash Crash and similar instances before and after were accelerated by high-frequency trading (HFT) and rogue algorithms. High-frequency traders profit from the smallest arbitrage opportunities available. These arbitrage opportunities cannot be spotted quickly enough by humans, so these traders rely on technology, co-location hardware, and high-tech algorithms to find, analyze, and react to the information with little to no human interaction. There’s little regulation in place for monitoring and reacting to rogue algorithms today. This all begs the question: why has the SEC chosen to develop a rule that doesn’t necessarily address the root of potential market volatility issues?

What will happen as HFT firms migrate to other asset classes and instruments where the Limit Up-Limit Down Rule does not exist?

With the advent of this new Limit Up-Limit Down rule, the onus is on broker-dealers to have a system in place that will not allow executions to occur outside the set price bands nor quote outside the price bands, and will monitor for executions that might occur during a halt after a limit state has been enacted for more than 15 seconds. Broker-dealers will also need to have access to this market data to truly understand the price band movements and how this may impact their resting limit orders.

In the end, it feels like this rule is a blanket oversight that fails to tackle the real issue around extraordinary market volatility, the rise of high frequency trading and rogue algorithms. When it comes to Limit Up-Limit Down, when will the regulators realize their limits?

More Commentary
A Wild Ride Comes to an End
Covering the financial services technology space for the past 15 years has been a thrilling ride with many ups as downs.
The End of an Era: Farewell to an Icon
After more than two decades of writing for Wall Street & Technology, I am leaving the media brand. It's time to reflect on our mutual history and the road ahead.
Beyond Bitcoin: Why Counterparty Has Won Support From Overstock's Chairman
The combined excitement over the currency and the Blockchain has kept the market capitalization above $4 billion for more than a year. This has attracted both imitators and innovators.
Asset Managers Set Sights on Defragmenting Back-Office Data
Defragmenting back-office data and technology will be a top focus for asset managers in 2015.
4 Mobile Security Predictions for 2015
As we look ahead, mobility is the perfect breeding ground for attacks in 2015.
Register for Wall Street & Technology Newsletters
Video
Exclusive: Inside the GETCO Execution Services Trading Floor
Exclusive: Inside the GETCO Execution Services Trading Floor
Advanced Trading takes you on an exclusive tour of the New York trading floor of GETCO Execution Services, the solutions arm of GETCO.