Stop Trading... but why?

It happened again this week - the meme stocks went haywire. This time the poster child wasn’t GameStop, but AMC. You can read recaps on the crazy AMC week here and here. My favorite recap is from Josh Brown appearing on MSNBC - here.

As you can see in the table below, shares of AMC, while down 23.41% over the last two days, were up a whopping 80.66% for the week. They are up 393.41% for the month, and just a mere 2159% year to date.

Other so-called meme stocks have also gone along for the ride this month. GameStop has stayed out of the spotlight, but has managed to rally 53% over that time. BlackBerry shares are up 61% on no stock specific news. Lastly, who can forget the lovable Build-a-Bear Workshop - in a Beanie Baby-like frenzy, shares of $BBW have more than doubled over the last month.

The moves have gotten so crazy that one Bank of America analyst stopped coverage of GameStop and moved Bed Bath and Beyond to ‘no rating’ saying that meme stocks no longer trade on fundamentals. They added that neither company has issued material updates or news to justify the surge in their stock prices.

Just thinking out loud…. Maybe they need to bring back a technical research department. But I digress…

The topic that has a me writing this week came as a result of the excessive volatility in AMC. As a result of the intraday parabolic swings, we got to revisit the trading halt.

Sadly, some people hear trading halt and are quick to chirp on the internet, yell that they are being disadvantaged, or scream that someone is out to get the little guy. This couldn’t be further from the truth. These pauses are put in place to try and settle things down and give everyone a chance to breathe.

What are Circuit Breakers?

Circuit breakers are regulatory measures put in place to settle the markets when things get too volatile. Initially the first circuit breakers were established after the market crash of October 19, 1987 - aka, Black Monday. The “market” - in this case, we are discussing the Dow Jones Industrial Average - fell by 508 points, or 22.6% in a single day.

Quick side story - the gentleman featured on the left in this iconic photo is the one and only Danny Kragh of Spear, Leeds and Kellogg. He was one of my early mentors and a great example of what made the NYSE community so unique and special.

Getting back to circuit breakers… like most regulatory changes on Wall St., they are generally instituted in a reactionary way to improve a short coming in the current system and avoid a repeat of the recent event in question.

As a result of Black Monday, the circuit breakers - or market pauses - were implemented to curb panic selling and avoid a repeat of October 19th, 1987. Initially these pauses were set at wide increments of 10%, 20% and 30% in the DJIA. If we hit any of the first two circuit breakers, we would pause. If we hit the third, we would close for the day. *Spoiler alert - we have never hit the third market circuit breaker.

The duration of this pause has changed dramatically over time as has the percentage of the drop. In fact, the Dow is no longer considered “the market” when using the market wide circuit breaker. We now base percentage drops in S&P 500 terms.

The current circuit breakers are divided into three tiers..

  • The Level 1 circuit breaker kicks in once the SPX drops 7% from the prior day.

  • Level 2 circuit breaker is triggered with a 13% decline.

Level 1 and Level 2 circuit breakers can be triggered between 9:30 a.m. and 3:25 pm Eastern time, and in both cases, trading is halted for 15 minutes.

  • Level 3 circuit breaker is triggered by a 20% drop in the SPX, and trading is then halted for the rest of the trading day.

Before the 2020 selloff, U.S. market-wide circuit breakers had been used only once - in October 1997 - as the Asian financial crisis caused a major sell-off in the Dow Jones Industrial Average. During the Covid crisis in 2020, U.S. circuit breakers halted trading on four days: March 9, 12, 16, and 18. In fact, I discussed that live from the floor here.

What About Halting Individual Stocks?

It’s not just the overall market that halts when things get too volatile. The individual stock circuit breaker was put in place across all market centers as a result of the May 6th, 2020 Flash Crash.

Now you can’t blame me for the events of 5/6/10. I was off that day. I was busy on my Goldman Sachs community teamworks assignment helping out the local community. But boy did I hear all the fun details about the events of that day when I hit the floor the following morning.

On that day the Dow fell 1000 points in just under 10 minutes. It didn’t trip a level one circuit breaker because they were still set at 10%. We were down about 9%. However, the moves to the downside in some individual stocks was the equivalent to a once in a lifetime market crash. Some individual names lost 20%, 30%, even 40%+ of their market value in just minutes. As a result of this “flash crash” the individual stock circuit breaker was implemented and still holds true to this day.

Here are the current individual stock circuit breaker thresholds.

Why Do We Halt? Crypto Never Halts.

Don’t get me started on the whole crypto market. Crypto trades around the clock and on weekends. It’s a ton of fun to trade and watch, but they don’t report earnings, aren’t responsible to shareholders, aren’t really regulated and not nearly as widely held as individual stocks. I could go on and on if you like.

Now we see more crashes in the crypto market more often than we do on the NJ Turnpike. Both of these events have come to be just normal and expected. Alright, forget crypto and let’s pivot back to the topic at hand… why do we ever stop trading? I’ll put it to you in layman’s terms.

In the case of the market wide circuit breaker, it’s to calm things down and take a break. Let’s breathe for a few minutes, reassess and start all over again. In the four instances it occurred during March 2020, three of them stemmed the selling and the market stabilized a bit. On the fourth occasion we sold off a bit more, but never got close to a level two halt. However, the rush - or panic if you will - eased. The circuit breakers did their job.

So why stop individual stocks?

This one is easy. It’s not to fix any game or change the rules to the benefit of one participant or another. Like the market wide break, we need to pause and reassess the current situation. We do this to both the upside and the downside in individual names.

We have never seen markets move faster. With the improvements of technology things happen in nanoseconds. So can big moves. If we hit that threshold we want to ask - why?

Was there news? Then let’s pause, look into it and get on the same page.

Was there a fat finger error? Imagine being the new guy on the desk asked to buy 10,000 shares of stock XYZ. You get a little nervous and add one extra zero to your total and hit done. OOPS - that’s a 100,000 share order and that may cause an individual stock to move into a volatility trading pause (VTP). We halt, look into the error and hopefully resolve it in a timely fashion.

Are there rumors or excessive speculation? Let’s take a break and see if we can figure things out.

Remember, these are public companies that want to know what’s happening. As a former NYSE market maker, I’ve been on the other end of calls from CFO’s and CEO’s wanting to know what’s going on in their stock. That pause is a good way to help find out and also a good time to update them as well.

When the stock goes up - it’s clearly because the company is great. When it goes down - I better have some answers.

How Does This Relate To AMC?

We saw VTP’s multiple times this week in AMC - both to the upside and downside. This was very similar to the GameStop saga I mentioned here (under Exhibit B). Did we need to pause? Um, yeah. Sometimes taking a break and letting the human touch and eyeballs get involved is necessary.

Will the moves always make sense? Not necessarily in this meme universe, but we must try to keep things as orderly as possible. The pause attempts to do this. For now the meme stocks just ignore what the pauses were intended to do. Key words.. for now.