What's Fueling Stocks' Late-Day Price Swings?
Marisha Chinsky, a spokeswoman for Nasdaq OMX, the largest stock-exchange operator by volume, says statistics for the last month confirm that market volatility and volume have been greater near the end of the trading day. In fact, triple-digit point moves, both up and down, occurred on eight days of one 10-day trading period.
Growing Suspicions About High-Frequency Trading
Although market experts say it's still unclear what's causing these sudden moves, there are growing suspicions that high-frequency traders -- who use sophisticated computer programs to buy and sell huge amounts of stock in hopes of earning tiny profits on each of their millions of trades -- may be causing the increased price movements. Market experts estimate that high-frequency traders now account for between 50% and 70% of all trades.
Alex Manzara, a broker at Chicago-based TJM Institutional Services, says high-frequency traders contribute to the volatility in a number of ways. First, some of them have rules against carrying open positions after the close of trading. "So if they've had positions on, they cover them at the end of the day," Manzara says. That means these traders often sell large positions at the very last minute to balance their books, causing prices to move sharply.
Another way high-frequency trading affects the movement of stock prices is that they can suddenly leave the market. High-frequency traders have become the main providers of liquidity -- those offering to buy and sell stocks. When they suddenly shun the market, as happened during the May 6 "flash crash," fewer buyers are available to prop up stock prices, and stocks can plunge suddenly.
Limit Orders Outpaced by High-Speed Trading
"We are in a world where liquidity is taken for granted, especially here in the U.S., and part of this liquidity is provided by the high-frequency traders," Manzara says. "When a little bit of that starts to disappear, [price movements] can be magnified."
Michael Goldstein, a professor of finance at Babson College in Babson Park, Mass., says the nature of high-speed trading has left other investors unwilling to use a type of trade known as a limit order. There are two types of trades: Market orders, where you can trade immediately at whatever the price is, and limit orders that specify a price at which you will trade.
"Limit orders act like a football team's front line, they hold prices from moving too fast," Goldstein says. But many investors are now leery of using limit orders because trading is so fast that markets can move sharply down before there is time to react. "Really, the markets have moved in such a way that there is a disincentive for people to put in limit orders," Goldstein says. "Markets are trading in milliseconds, or a thousand times as second, so you're leaving yourself out there in the open if you use a limit order."
Time for a Speed Limit?
Goldstein has asked the Securities and Exchange Commission to enact rules that limit the speed at which high-frequency trades take place. He says that two years ago, such trades happened at 10 milliseconds, or thousandths of a second, but now they are being executed in microseconds, or millionths of a second.
"On the highway, there is a speed limit," he says. "Although my car can hit 140 miles per hour, I can't drive 140 mph on the highway. It may be time to put on a speed limit."
He says trading is now so fast that it happen faster than the speed of light moves between New York and such other financial centers as Boston and Chicago. That means brokers in these other cities can't know what the most recent quote was in New York.
Rise in End-of-Day Volatility
Goldstein says this helps explain the recent rise in volatility at the close of trading. "I wouldn't be surprised if right at the end of the day, there's a lot of people who have to unwind positions, and since we can trade so fast, we can see a lot of reversals pretty quickly."
Manzara says the problem of late-day volatility is so persistent that there are rumors in the market that someone or some institution is intervening at the last minute to avoid a share crash.
"There is this pervasive feeling that there's a plunge protection team that comes at the end of the day and tends to bid the market up," he says. "I don't know if that's right or not, but I've seen it happen a lot of times at the last half hour" of the session.
Some traders even speculate that the government is stepping in to stabilize the market, but Manzara says he gives those reports little credence.