As stocks drop, NYSE offers refresher on 'circuit-breakers'

They're designed to reduce volatility in trading

Fears that the major US financial markets would follow other markets as they dropped on Friday prompted the New York Stock Exchange (NYSE) to highlight rules about market-wide trading halts that kick in when indices plummet below certain pre-defined levels.

Those 'circuit breaker' levels are designed to reduce market volatility by forcing a pause in trading activity for certain periods of time. The NYSE posted a note on its Web site explaining the rules following what it said were questions about how circuit-breakers work. Circuit breakers to stem futures trading kicked in before the markets opened in New York on Friday after markets elsewhere in the world fell sharply.

The NYSE ended the day off by more than 300 points; The technology-laden NASDAQ shed 51 points. Neither was anywhere near as large as the sharp sell-off late last month.

Basically, circuit breakers are used to cut off automated trading program connections between large brokerage houses and the computers on the NYSE trading floor for varying lengths of time, depending in the severity of the decline and the time of the day it happens, according to the exchange's Invest FAQ.

Larger brokerage houses "have their computers directly connected to the trading floor on the stock exchanges, and hence can program their computers to place direct huge buy/sell orders that are executed in a blink," the FAQ said. "This automated connection allows them to short-cut the individual investors who must go thru the brokers and the specialists on the stock exchange."

Because of the speed with which trades can take place -- in microseconds -- circuit breakers are aimed at slowing a market crash.

In an indication of how worried traders were Friday morning, the NYSE took the unusual step of posting a statement on its blog confirming that trading would begin as usual at 9:30 a.m. The move was aimed at addressing widespread rumors about the exchange being closed or delayed.

NYSE introduced circuit breakers to halt trading during periods of "extraordinary volatility" like that seen in recent weeks. The rules detail how far the Dow Jones Industrial Average must drop for the trading halts to kick in. The trigger points are set at 10, 20 and 30 percent of the value of the DJIA -rounded off to the nearest 50 at the beginning of each calendar quarter. The DJIA had an average value of 11,000 at the beginning of the fourth quarter.

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Under the NYSE circuit breaker rules, if the value had dropped by 10 percent, or 1,100 points, at any time before 2 p.m. Friday, an automatic trading halt of one hour would have taken place, according to a NYSE description of how the breaks would work.

If the Dow were to drop by that amount between 2 p.m. and 2: 30 p.m., trading would be halted for 30 minutes. There would be no trading halt if the drop occurred later than that.

A 20 percent decline would mean a two-hour trading halt if it occurred before 1 p.m., a one-hour halt if it took place between 1 p.m. and 2 p.m. and a market closure if it happened after that. A 30 percent decline, which for this quarter would be a 3,350-point drop, would trigger an automatic halt to all trading for the day regardless of when it occurred.

The current trigger levels were set in April 1998.

The only time the triggers were pulled was in October 1997, when the Dow dropped by 350 points shortly after 2:30 p.m. That drop led to a 30-minute trading halt, but the market was later closed after the Dow continued its plunge and dropped another 550 points shortly after trading resumed that day.

That plunge and a brief one the next day were caused by economic turmoil in Asia and concerns over how it would affect the earnings of US companies according to an analysis by the Division of Market Regulation of the US Securities and Exchange Commission.