NYSE Pressure Valve Highlighted in Plunge
By STEVEN D. JONES
A pressure valve at the New York Stock Exchange prevented Thursday's selloff from crushing shares traded on the Big Board. But it may have exacerbated plunges on other bourses.
As a ferocious selloff gripped Wall Street late in the day, shares of many major companies plunged with some briefly dropping into penny territory. For example, Exelon Corp., a giant Chicago utility, dropped below a dollar after opening the day at $43.35.
The cause of the selloff remains unknown. What is becoming clearer: A NYSE mechanism designed to prevent rapid drops in the price of stocks traded on its floors may have contributed to the fall in prices of those stocks on other exchanges.
Late in Thursday's session, the NYSE instituted a "liquidity replenishment point" for several stocks it trades. The LRP, as it is known, switches trading to auction-based transactions from electronic. LRP is, essentially, a breather that slows down -- but doesn't stop - trading in an effort to find more rational prices.
Here's how it works. When bids for an NYSE-listed stock suddenly drop, the exchange's market makers start an auction process that uses available bids and asks. The process is designed to match prices to the advantage of both parties. Trades can take more than a minute to be completed, much longer than the milliseconds electronic trades require. The NYSE prides itself on such flexibility.
"We are an electronic market but we have the ability to conduct an auction when there is a premium for human judgment in the trade," Ray Pellecchia, an exchange spokesman, said.
At 2:45 p.m. NYSE received a wave of sell orders for Procter & Gamble Co., triggering an LRP for the stock. P&G's market maker immediately began an auction and the price never fell below $56 on the NYSE.
That's the way LRP, which was instituted in 2006 and triggered by at least a few shares almost every day, is supposed to work. But because the exchange is the primary listing place of many of the country's biggest companies, LRP removes a large amount of the overall market's bids and asks. When other electronic platforms have fewer participants and less data prices become fragmented.
In a 2004 document detailing how the exchange would integrate its electronic and auction process, the NYSE explained that during LRP auctions investors could take trades to other exchanges "to obtain an automatic execution in another market, even if that price is inferior."
Traders on other platforms should have been aware of the NYSE's use of LRP. Every time it institutes the practice, the exchanges raise a flag on affected stocks on every other trading platform to alert market makers.
But with the stock market crumbling, few traders may have had time to look up.
— Steven D. Jones is one of five In The Money columnists who take a sophisticated look at the value of companies and their securities and explore unique trading strategies. He can be reached at steve-d.jones@dowjones.com |
