About Last Thursday: More Circuit Breakers or Fewer?

To break a circuit or not, that is the question.

As The New York Times reports today that major exchanges have agreed upon a new set of rules to avert future crashes like the one that happened last week, it’s still not clear what role the technology of modern trading played in the near-1,000-point decline.

The major equity exchanges “agreed on a structural framework, to be refined over the next day [...] that would allow for a controlled slowdown during volatile trading,” write Graham Bowley and Edward Wyatt of the Times.

But as the authors write, the role of the circuit breakers was paradoxical:

The plunge was an unintended consequence of a system built to place a circuit breaker on stocks in sharp decline. In theory, trades slow down so that sellers can find buyers the old-fashioned way, by hand, one by one. The electronic exchanges did not slow down in tandem, causing problems, according to two officials familiar with the investigation.

Well, Former NYSE (NYX) CEO Dick Grasso weighed in today with his view of the melt-down last Thursday in an interview with Bloomberg’s Kathleen Hays. He thinks that “Circuit breakers could have prevented a lot of what we saw last Thursday.”

�In times of free markets, technology, innovation and human nature prevail, and that creates competition, but in times when free markets become free-for-all markets the regulators have to get everyone in the room, as they�re doing today, and say, �this is how we�re going to serve the least sophisticated person in the market,�� Grasso said. �When we protect that person, everyone flourishes.�

To complicate matters further, the FT’s Alphaville picks up on a note this morning from Barclays which says that no one factor — technology glitches nor high-frequency trading, or the like — contributed to the melt-down, but that rather, it was a “perfect storm” that was a both a normal run on the market and also compounded by the lack of enough algorithmic trading, not too much of it:

The trading day [Thursday] got off to a bad start with markets down 2%-3% on macro concerns about European sovereign debt risk�By late morning, in fact, the percentage of NYSE-listed volume trading on a down-tick at the same time had approached levels not seen since the morning trading resumed after 9/11. In other words, there was already a lot of fundamental selling pressure in the market, and we believe the rising risk aversion of investors did not need much of an acceleration in the sell-off to run for the exits.

Once the circuit breakers were triggered on NYSE by that fear, algo traders got out of the market, according to Barclays:

The market structure in US cash equities trading has evolved over the past few years to depend heavily on high frequency algorithmic trading entities which behave like �pseudo market makers�. In Thursday�s volatile market conditions, we believe that much of the liquidity provided by these trading entities disappeared as these traders sat on the sidelines. The net result was that during the period of heightened market volatility, these trading entities were not active in the market and that there were few fundamental buy orders to take their place given the risk-aversion discussed above thus leaving little price support in place.

So, does all this mean we need more circuit breakers? Fewer? �Something else?

Update: Bloomberg’s Jesse Westbrook reports this afternoon that a meeting by the Securities & Exchange Commission and the heads of the NYSE and other exchanges did not produce agreement as to what may have precipitated Thursday’s activity.