The technology that makes stock exchanges work has come a long way since Black Monday.
"Let me describe market technology in 1987," said James Angel, a professor at Georgetown's McDonough School of Business. "There was none."
The Oct. 19, 1987, market crash demonstrated that the system of human brokers and paper order tickets could not handle the deluge of trades that occurred as markets melted down.
"They did have an electronic order entry system that would bring in an order and print a paper ticket that a flesh and blood floor broker would take and walk over to the specialist," said Angel, who testified before Congress after the Flash Crash. The specialist was "kind of like the traffic cop" for the brokers but had other roles, such as acting as a market maker.
The flesh-and-blood system had serious problems when volume on the New York Stock Exchange reached 604.3 million, nearly double the previous record. The recent advent of "program trading" that enabled computers to place orders contributed to the flood of orders that overtook the exchanges. "When you read the history of markets you see this happening over and over again," Angel said. "When the market is overwhelmed by the crush of activity, things fall apart."
Electronic trading has replaced the open outcry system, and a vast Mahweh, N.J., data center has replaced the paper order tickets that drove the NYSE. "It was a lot harder to control what was happening because it was just people and you have the mob mentality," said Jon Butler, a managing director in Deloitte's technology team. "Now it's all electronic."
The SEC established circuit breakers that have been tweaked over time. Trading stops for 15 minutes after a drop of 7% before 3:25 p.m., and again at a drop of 13%. A halt of 20% or more halts trading for the remainder of the day, regardless of the time. "The exchanges have curbs in place that will kick in after a certain amount so you're never going to see massive moves," Butler said.
Other regulations limit short selling if a stock drops more than 10%. The rule enables long investors to "stand at the front of the line" and sell before the shorts to "preserve investor confidence and promote market efficiency," the SEC said in 2010 when establishing the rule.
"That level of control is not something that would have been possible in the old pit trading days," Butler said.
The Flash Crash -- a wild 36-minute market plunge on May 6, 2010 -- has heightened the debate about high frequency trading.
"In the aftermath of the Flash Crash, the media became particularly fascinated with the secretive blend of high-powered technology and hyperactive market activity known as high frequency trading," a study prepared by the U.S. Commodity Futures Trading Commission stated. The study determined that high frequency trading did not cause the Flash Crash, but contributed to it. High frequency trading can also benefit the market, by providing liquidity and stabilizing prices when other buyers are not present.
While circuit breakers have had limited crashes in recent years, said Larry Tabb, founder of investment research and advisory firm Tabb Group, we could still have another meltdown. "That market meltdown would not necessarily be technically drive or market-structure driven as it would be supply demand driven, which is appropriate," he said.
The emergence of more than a dozen exchanges and more than 30 dark pools or alternative trading systems could also contribute to volatility. Tabb suggested. "The exchange fabric is much more--some people would call fragmented others would call competitive," he said. The wide distribution of trades across so many exchanges make it "easier to have these mini crashes or flash crashes," he cautioned.
Events in China earlier this year illustrate the shortcomings of circuit breakers. Chinese regulators put breakers in place in early January, but scrapped the protections after just four days when they repeatedly halted trading and arguably contributed to volatility. "They kicked in and man did it cause a mess," Angel said.
Circuit breakers can exacerbate crashes, Angel suggested, because traders may become frenzied if they fear markets will shut down. Closing a market can have ripple effects. "If they had shut down the market at the bottom of the Flash Crash imagine the panic that would have ensued," he said.
One certainty is that another crash will come. "It will probably handle it a whole lot better than 1987 that's for sure," Angel said. "But when the market wide circuit breakers get triggered it will probably be a mess."
Black Monday made headlines 30 years ago today. Check out our full Crash of '87 Special Report for the ultimate #TBT:
- What You Need to Know About Black Monday: Explainer
- Has Wall Street Employed Enough Tech to Protect Against Another Black Monday?
- What Led to the Black Monday Crash?
- Vanguard Founder John Bogle Reflects on Black Monday
Originally published Oct. 18.