ETF ‘Circuit Breakers’ Needed To Stop Flash Crashes (CNBC)
Stock market circuit breakers halt the trading of individual stocks that may make up the funds, but for now the ETFs can keep on trading regardless of what their components do.
That presents the potential for more trouble on Wall Street in the form of arbitrage moves that high frequency trading programs make—playing the ETFs one way and their individual stocks another way and then capitalizing on the narrow price differences in between.
Because the computer programs trade so quickly, that small price difference can soon escalate out of control and the ETF can change rapidly in value. At least one firm thinks that’s exactly what happened to trigger the flash crash.
“It’s a process question that is rooted in the essence of what the ETFs are,” says Thomas Peterffy, chairman and CEO of options trading firm Interactive Brokers.
Part of the problem is that when the price of an individual stock changes, it’s not immediately reflected in the ETF, which is basically a basket of stocks tied to a particular index like the Standard & Poor’s 500 (SPX). The high frequency trading programs take advantage of this pricing gap—called arbitrage—with high volume buying and selling to make a quick profit.
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