Day traders need volatility in the markets but what happens when volatility becomes too much and what triggers a volatility halt?
Earlier this year, we witnessed extreme volatility in “meme stocks” such as GameStop ($GME) and movie chain AMC Entertainment Holdings ($AMC) which triggered trading halts.
Several other once-sleepy stocks like Bed Bath and Beyond ($BBBY) and Koss ($KOSS) were also restricted by just about every major brokerage platform catering to retail traders.
In this blog post, we will explain what volatility halts are and how market circuit breakers work.
What is the meaning of a volatility trading halt?
A trading halt is a temporary pause of trading for a particular stock or security at one exchange or across numerous exchanges.
The law allows stock exchanges, markets, and the U.S. Securities and Exchange Commission (SEC) to halt trading on individual securities to protect market participants and level the field between reactive, informed traders and those lagging on important news.
Trading can be halted in advance of price-moving company news, to correct an imbalance from inordinately heavy volumes, or if a stock fails to comply with regulatory requirements.
Types of trading halts
When a company goes public, it is under the supervision of the SEC or state regulatory agencies that oversee public companies, as well as the stock exchange that has agreed to list the shares.
This means that the company is obliged to provide affiliated stock markets advanced notice of price-busting news, such as product or acquisition updates, restructurings, significant changes in management or finances.
The regulators examine corporate announcements and decide whether the potential impact merits a trading halt. Trading can also be halted in response to major events that are beyond corporate control, such as business-affecting natural disasters or on already public information.
If the stock is trading in other markets, they too will be required to enforce concurrent suspensions. The regulator authorizing the halt will reopen trading based on its own assessment, at which time all other listings can resume.
Stock market regulators can also halt trading if a stock is not in compliance with listing standards.
For example, the SEC can pause stock activity for up to 10 trading days if it registers risk to the investing public based on a variety of factors, including poor quality or timeliness of a company’s required filings, as well as suspected stock manipulation.
Some trading suspensions will automatically happen when a stock reaches its daily trading limit and use up its allotted trading contracts in a given session. These limits are designed to shield traders from extreme volatility.
Moreover, if a company publishes important news after the closing bell, exchanges might then pause the opening of the stock the following day to correct imbalances from post-market orders. These pauses are not obligatorily enforced on peripheral markets.
Non-regulatory halts cannot be imposed by stock markets such as the Nasdaq and are exclusive to exchanges such as the New York Stock Exchange.
That’s why Nasdaq trading halts are known always to occur before announcements, while NYSE halts may only signal high volatility.
While most volatility-based halts are stock-specific, there are also market-wide circuit breakers, which are approved by the SEC to prevent volatility-inspired panic trading.
In stock markets, a circuit breaker is when the market is shut down momentarily if it hits a predetermined threshold. There are certain breakers set for a variety of markets.
Also known as collars, circuit breakers were first imposed after the Black Monday market crash of 1987 and now occur when prices move a certain distance.
The duration of the halt depends on the time of occurrence and the percentage of movement.
How circuit breakers work
Per the rules, circuit breakers are triggered after a massive slump in the S&P 500 index. A fall of 7% from the close of the previous trading session activates the Level 1 circuit breaker threshold. This suspends trading for 15 minutes.
If the index sinks by 13% from the close of the previous trading session trading is suspended for an additional 15 minutes after the resumption.
However, for the Level 2 circuit breaker threshold to be triggered, the decline has to happen before 3:25 p.m. ET.
The Level 3 circuit breaker is triggered by a decline of 20% from the close of the previous trading session in the S&P 500.
- Level 1: If the S&P 500 declines 7%, trading will be suspended for 15 minutes.
- Level 2: If the S&P 500 drops 13%, trading will again be halted for 15 minutes if the slump happens on or before 3:25 p.m. ET. There will be no halt if the slump occurs after that
- Level 3: If the S&P 500 declines 20%, trading would be suspended for the remainder of the day.
Notable trading halts on Wall Street
The panic of 1873
A Philadelphia bank known as Jay Cooke & Company declares bankruptcy due to feeble demand for its railroad bonds.
Jay Cooke was one of the biggest underwriters of treasuries and triggered a panic that reverberated throughout the broader stock market.
The New York Stock Exchange halted trading for 10 days as a result of the bankruptcy.
July 31, 1914
During World War I (the Great War), the New York Stock Exchange shut down its operations completely after many foreign traders began selling their stocks hoping to raise money for the war effort.
The halt started on July 31 following a plunge of 20% or more in blue-chip stocks and went on for another four and a half months.
To this day, it is the longest stoppage in the stock exchange history. All of the world’s stock markets followed suit and paused trading by August 1.
Black Monday 1987
The Black Monday market crash occurred on October 19, 1987, when all three levels were activated after the Dow fell by 22.6%. The S&P 500, on the other hand, fell by 20% on the other hand
The crash was blamed on among others an ailing U.S. economy, geopolitical tensions, and falling crude oil prices.
Historians also believe that computerized trading, which was still in its infancy, may have contributed to the crash.
9/11 terrorist attacks
The U.S. stock market never opened following the terrorist attacks of Sept 11, 2001, on the World Trade Center in New York.
The NYSE and Nasdaq chose not to open for trading that day and remained closed until Sept. 17 given the confusion surrounding the source and implications of the attacks, and proximity to Wall Street.
The two exchanges remained shut until September 17, making it one of the longest closures in Wall Street’s history.
May 6, 2010 flash crash
On May 6, 2010, the Dow dropped by 1,000 points in a span of 10 minutes. This was the biggest slump on record at the time and is thought to have cost $1 trillion in equity.
The Dow then promptly shot back up again, recouping nearly all of the earlier losses leaving regulators and traders baffled and traumatized.
In its report on the events of the flash crash, the SEC put the blame on a British trader Navinder Singh Sarao who initiated a sell program to sell a total of 75,000 E-mini contracts (valued at approximately $4.1bn) as a hedge to an existing equity position.
2020 Covid crash
On March 12, 2020, U.S. stock markets briefly shut down due to a massive sell-off that was sparked by fears about the coronavirus global pandemic.
The sell-off was predicted by stock futures, which began to slide shortly after then-President Donald Trump announced the previous evening that he would impose a travel ban on European nations.
Tensions from growing coronavirus concerns, the sudden WHO’s decision to declare the disease a pandemic, and the NBA canceling its season also spooked the market.
Markets opened at 9:30 am ET on March 12, and the Level 1 circuit breaker was triggered approximately six minutes into the session.
“Meme stocks” trading halt, 2021
Earlier this year, retail traders were outraged when popular stock trading app Robinhood ($HOOD) halted buying of the so-memes stocks – companies like GameStop and AMC.
Robinhood initiated the halt during a Reddit-inspired trading frenzy in January, which saw millions of novice traders push GameStop and AMC stocks and options to extreme highs.
The trading app only allowed traders to sell.
Robinhood blocked purchases of several hot meme stocks as the hype increased, telling traders that it was forced to restrict the trading to comply with the rules of its clearinghouse.
Other online stock brokers also followed suit by imposing some restrictions.
As a full-time day trader, it’s certain that you will get caught in volatility halts once in a while. This is why it is important to know why halts occur, what causes them, and how to deal with them.
While stocks are halted, they cannot be traded by anyone. In addition, brokers cannot publish indications or quotations of interest.
However, not all activity is inaccessible. Traders can take part in options trading or cancel open orders.
Trading generally resumes within the hour and often occurs on rectification of halt-worthy conditions. But when trading resumes, the stock can reopen at any price. There really isn’t a lot you can do if you get caught in a halt but to wait until trading resumes.
The post What Triggers A Volatility Halt In Stocks? appeared first on Warrior Trading.
Original source: https://www.warriortrading.com/what-triggers-a-volatility-halt/