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Limit Up-Limit Down v. Circuit Breakers

Back-and-forth, side-to-side. The “limit up-limit down” measure of preventing another Flash Crash is down one minute and back up the next. It seems to be back up at the moment, after financial services leaders and regulators met at a Securities Industry and Financial Markets Association (SIFMA) conference last week.

A U.S. Securities and Exchange Commission official “gave glowing reviews to limit up-limit down” during his speech, according to Traders Magazine, calling the measure an improvement over the circuit breakers in effect today. And SIFMA general counsel Ira Hammerman used his keynote to stress that balance and effectiveness would be essential to new regulatory success.

Circuit breakers are a market safety feature designed to prevent another May 2010-style computer-induced plummet in trading prices. Critics maintain the measure does not distinguish genuine market movements from the sinister robo-drops.

Meanwhile, limit up-limit down would let equities trade within set boundaries, pausing relatively briefly if prices stray beyond them. Think of those boundaries as a limit up above your current price, and a limit down below it. But this measure hasn’t always been on the upswing.

A Yale University and Barron’s study revealed last month that limit up-limit down was more complex than circuit breakers. Therefore, it required greater scrutiny, the study said.

But limit up-limit down may have gotten another shot in the arm recently with a different study, this one from the Lawrence Berkeley National Laboratory. Where Yale and Barron’s found limit up-limit down too intricate, “Federal Market Information Technology in the Post Flash Crash Era: Roles for Supercomputing” found circuit breakers too heavy-handed.

“These are very ‘blunt instruments’ that do not allow the market to self-correct and stabilize, and they can easily make a bad situation worse,” the study said. “Our tests showed that VPIN, HHI and similar indicators could provide early warning signals for a more gradual ‘slow down, rather than stop’ replacement for on/off circuit breakers.”

So there we are: an empirically proven happy medium between limit up-limit down and circuit breakers. Now all we have to do is wait for the SEC to test and approve it in every way possible: back-and-forth, side-to-side and of course up and down.


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