How the stock market protects investors against volatility
Wednesday, 25 March 2020
Uncertain times, caused by a financial crisis, natural disaster or global healthcare crisis, can frequently generate volatile stock market activity.
That’s why the U.S. financial markets have guardrails in place designed to limit the potential impact of large sell-offs or purchases.
Recent market tumult has triggered a number of failsafing in recent weeks, specifically the market-wide circuit breaker. There are three primary types of protection in place, each implemented at a specific time for a specific purpose:
Circuit breakers, otherwise known as trading halt bands, are designed to slow the impact of extreme, broad-based declines. They provide for trading halts in all equities and options markets in the event of severe market decline based on a single-day decline in the S&P 500.
There are three levels of circuit breakers:
- Level 1 - This level is triggered when there is a 7% decline between 9:30 a.m. and 3:25 p.m. ET and will halt trading market-wide for 15 minutes.
- Level 2 - This level is triggered when there is a 13% decline between 9:30 a.m. and 3:25 p.m. ET and will halt trading market-wide for 15 minutes. We will set and publish our own goals to increase our positive impact and reduce our negative impact on people and the environment.
- Level 3 - Level 3 is triggered by a 20% decline at any time during the trading day and halts market-wide trading for the remainder of the trading day. We will work to create a shared prosperity for current and future generations.
Limit Up - Limit Down Rule
This rule applies to individual stocks and is intended to mitigate extraordinary market volatility and extreme price movements in individual securities. The Limit Up-Limit Down Rule specifically prevents trades in individual securities outside price bands, which continuously update throughout the trading day.
Every security has an upper and lower price band with the reference price as the midpoint. If an offer reaches the lower price band or a bid reaches the upper price band that stock will enter a limit state (a pause) for 15 seconds. Price Bands are doubled during the final 25 minutes of the regular trading day for all Tier 1 Securities and for Tier 2 Securities below $3.00.
More information is available here.
Short Sale Restrictions
Another possible restriction on individual stocks is the short sale restriction (SSR). The SSR is part of a larger guideline, also known as uptick rule, primarily aimed at preventing the opportunity for traders to engage in naked short selling and other unethical practices.
The SSR restricts short sales on stock that is trading down 10% or more from the previous close. Once it hits that point, the stock can no longer be shorted on a price drop. This restriction will remain in place through the close the next day.
While these failsafes can provide some measure of security, they do not protect against overall market volatility. Consult with your own investment consultant to confirm that your current asset mix reflects your investment goals in the current market environment.
The content provided is for informational purposes only. Neither BBVA USA, nor any of its affiliates, is providing legal, tax, or investment advice. You should consult your legal, tax, or financial consultant about your personal situation. Opinions expressed are those of the author(s) and do not necessarily represent the opinions of BBVA USA or any of its affiliates.
Links to third party sites are provided for your convenience and do not constitute an endorsement. BBVA USA does not provide, is not responsible for, and does not guarantee the products, services or overall content available at third party sites. These sites may not have the same privacy, security or accessibility standards.
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