Human Judgment Needed or Computers Bid $.01

I have received several emails from people thinking Thursday's market plunge was a "planned event".

On the surface the idea is preposterous, and even more so when one realizes financial reform was being debated in the Senate, and the last thing Wall Street wants is more attention and stricter controls on anything.

With that in mind, please consider What hit the market?

New York Stock Exchange efforts to stabilize Thursday's stock market had the opposite effect, triggering a momentary market collapse.

It wasn't a goof. It wasn't human error. Rather, it was an instant that displayed the hazard of new markets that handle billions of dollars' worth of trades each day.

During yesterday's fast-moving midday market, NYSE specialists -- who oversee trading in individual stocks -- used their authority to call a momentary time out. The idea was to bring together buyers and sellers, and get their prices more in line with each other.

It happened in five Dow stocks, including 3M (MMM, Fortune 500) and Procter & Gamble (PG, Fortune 500), according to the NYSE, and in a good number of the listed stocks. The NYSE did not have a tally of exactly how many.

Years ago, when the NYSE dominated trading, such "time-outs" worked well at stabilizing stock prices.

But today, the NYSE accounts for only about 25% of the volume in its listed stocks. Much of the rest comes from computerized markets run by private companies -- and some of those systems did not take a time out yesterday.

So, as the NYSE paused for a minute or two at about 2:40 p.m. ET, the off-exchange computers kept searching to execute trades. They hit the best bids still standing, which in many cases were far below the prior price.

And in some cases, the off-exchange computers found no bids at all. When that happens, market-making computers see a zero bid, then offer a penny higher to capture the trade and collect a commission -- hence the trades of just one cent for several stocks, including Accenture (ACN), Boston Beer (SAM), Exelon (EXC, Fortune 500).

"Computers are looking for the best bids. The real best bids shut themselves down," one trader told CNNMoney.com.

"You had penny prints. The bid was zero. The algorithms were designed to penny the bids," said another trader.

The attempt to stabilize the market by timing out the human bidders made matters worse. The computers reacted by bidding $.01 when there were no other bids.

This was not a planned conspiracy. Rather, it was a natural occurrence after all the sell stops and buy stops executed, the NYSE paused, and the only game in town was computers bidding against computers finding no bids.

The only question is whether or not the computers did indeed in every case route orders to the best bid as required by NBBO National Best Bid and Offer rules.

For more on canceled trades and best bid rules, please see Corporate Bond Sales Plunge 86%; Stocks Down on Day, Week, Year.

I am continually amazed at how otherwise sensible people manage to come up with preposterous conspiracies when anything out of the norm happens.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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