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Originally published Wednesday, May 19, 2010 at 2:43 PM

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Traders put faith in 'circuit breakers' after dive

Two weeks after the stock market's record dive, regulators have a plan to keep it from happening again by essentially calling "time out" when trading gets too chaotic. The question is whether that will work.

AP Business Writer

NEW YORK —

Two weeks after the stock market's record dive, regulators have a plan to keep it from happening again by essentially calling "time out" when trading gets too chaotic. The question is whether that will work.

The big exchanges say that new curbs on trading known as "circuit breakers" will help prevent runaway market drops. But not everyone is convinced. To some market watchers, the rules are too limited. To others, the rules go too far.

The reality is that we may not know who's right until there is another wild trading day like the one that stunned Wall Street on May 6. Intense selling sent the Dow Jones industrials down to a loss of almost 1,000 points in less than 30 minutes.

Under the plan announced Tuesday by the Securities and Exchange Commission, trading of any Standard & Poor's 500 stock that rises or falls 10 percent or more within a five-minute period would be halted for five minutes. The rules would be applied if the price swing occurs between 9:45 a.m. and 3:35 p.m. Eastern time. That's almost the entire trading day.

The idea is that by giving investors a break during extreme market dips, they'll be less likely to set off a chain reaction of human and computerized selling.

That's one of several possible causes of the May 6 plunge. The drop, which some market watchers are calling a "flash crash," briefly wiped out $1 trillion in market value as some stocks traded as low as 1 cent.

What if the new circuit breakers were in place that day?

"I believe that day would've played out significantly different," said Joe Ratterman, CEO of the third-largest U.S. stock exchange, BATS Exchange, which helped devise the new rules.

"There would've been chaos," Ratterman said, "but that pausing would've created enough breathing room for people to realize that the falling prices weren't based on fundamentals," or economic or corporate news.

"You wouldn't have seen all those stocks trading for a penny."

On May 6, about 30 stocks in the S&P 500 index fell at least 10 percent within five minutes. Halting trading of those stocks would have put a lid on the panic and kept more investors in the market, said Manoj Narang, founder and CEO of Tradeworx, a firm that uses super-fast computers to trade.

Narang's firm and others stopped trading on May 6 to avoid trades that would later be canceled. That can happen in times of extreme volatility, when the prices on some trades turn out to be wrong. Thousands of trades were indeed canceled that day. However, some analysts believe that by not trading, those firms accelerated the market's fall because they increased the vacuum of both buyers and sellers.

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"I would've loved to have kept trading because we would've done great," Narang said.

A trading pause would also give investors time to investigate whether a stock's drop is caused by a market-moving event or a technical glitch, Narang added.

"Taking five minutes to let people figure out what's going on certainly isn't harmful in my mind," he said.

Still, given that regulators have yet to determine the cause of the market's dive, some market watchers question how they can be so sure they can prevent another drop.

"I'm absolutely skeptical," said J.W. Verret, a former SEC defense lawyer who teaches corporate and securities law at George Mason University. "One risk I see with is that we're coming up with solutions before we understand the problem."

He called circuit breakers a "blunt instrument" that could interfere with the markets' role in determining what a stock's price should be.

"Sometimes a stock needs to drop," Verret said.

Others say the new SEC rules don't go far enough.

The new circuit breakers will apply to all 50 or so U.S. exchanges. But they would only kick in only for 500 of the some 8,000 publicly traded U.S. stocks. After a six-month trial, the SEC and the exchanges could expand the rules to include more stocks. In the meantime, some longtime traders aren't happy with the unequal treatment for stocks.

"If you're going to put in circuit breakers, then put them across the board," said Ted Weisberg of Seaport Securities.

Circuit breakers are "a Band-Aid, not a solution," said Weisberg, who has spent 41 years as a New York Stock Exchange floor trader.

But that may be all that's needed for now, said John Coffee, a securities law professor at Columbia University.

"This does not need to be the perfect circuit breaker," Coffee said in an e-mail. "All that is needed is a common rule that throws enough sand into the gears to prevent a computer-driven race to the bottom."

The exchanges are confident that circuit breakers won't interfere with the market's pricing of stocks, said Ratterman of BATS Exchange. Still, he cautioned that there's no guarantees that even with circuit breakers, the market won't see more wild drops.

"The nature of our markets is that anything is possible," he said. "You have oil spills, volcanos and the Greece crisis ...., and a lot of people have their finger on the sell button."

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AP Business Writer Marcy Gordon contributed to this report from Washington.

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