Recall that the equities exchanges embarked on a single stock circuit breaker program in June, passing rules to halt trading in stocks that rise or fall 10 percent or more in five minutes. As of now the program covers all Standard & Poor's 500 companies and will run through December. The SEC and the exchanges would like to extend the program to also cover stocks in the Russell 1000 and certain exchange traded funds. 

So how are the circuit breakers working? 

Most would agree the system at this early stage is far from perfect. The biggest flaw may revolve around erroneous trades. There are a couple of issues here. One of course is whether there should be some objective criteria governing the process by which trades are cancelled. The SEC and exchanges have indeed proposed some criteria regarding this. And we'll likely get a rule at some point. The other issue is potentially more vexing: What to do when clearly erroneous trades trigger circuit breakers. 

This was not unforeseen when circuit breakers were proposed and approved with the support of much of the trading community. At the time, the exchanges suggested they would not take erroneous trades into account when determining whether a circuit breaker should kick in. In practice, that has proved difficult. 

The most publicized example so far has been the case of Intel. In late August, three trades were canceled after a circuit breaker for the stock was triggered, setting off the required five-minute trading halt. This has led many to wonder if the circuit breakers are working as advertised, or whether the triggers are a bit capricious given they cannot account for erroneous trades that are destined to be canceled. Consider also the Core Molding case, which isn't an S&P 500 stock. In late August, 200 trades were canceled after the stock fell from roughly $4 to less than a penny in all of two seconds. If the rules were extended to many other stocks, the problems could certainly multiply.  

This is certainly frustrating for traders, as the market for single stocks can easily be held hostage to a few relatively small trades that perhaps shouldn't by themselves bring trading to a standstill. 

The Nasdaq seems to be aware of these issues. Nasdaq has proposed to the SEC to only halt trading if the trades in question are within the national best bid and offer. If not, the exchange would not immediately stop trading. Instead, the exchange would wait until three trades occur outside the NBBO. Only then would the required five-minue halt go into effect. Some version of this seems reasonable enough. Some would also like to see these rules instituted uniformly across all exchanges. 

Others wonder, however, if this system could account for trades that are not erroneous but are well outside the national best bid and offer. BATS has suggested getting rid of circuit breakers in favor of price bands, modeled on the futures market system, notes Traders. "The mechanism prevents trades from occurring a certain percentage away from a given reference price. Rather than halt trading once a stock reaches its outer price limit, the price band allows trading to continue but only within the price parameters." 

So will we get some refinements? The SEC "does not appear overly concerned about the snafus," suggests Trader magazine. SEC Chairman Mary Schapiro, at a joint SEC-CFTC investigative hearing on August 11, told panelists: "While we have had a number of triggers, I'd be interested to know if they have caused any harm to the marketplace. It's not my perception that they have." That said, I think we'll see some tinkering. - Jim