CSCO Circuit Breaker

On Thursday, the new circuit breaker rule was triggered for CSCO on the AMEX. CSCO didn't really increase sharply. A large market buy order was sent to the AMEX. The AMEX is only required to respect top-of-book on the other exchanges. According to current rules, other orders may be traded through.

The AMEX just started trading CSCO. There was thin liquidity on AMEX, and the other exchanges had small quotes. There were enough book orders on other exchanges to fill the AMEX order, but AMEX is only legally required to honor the quote.

Here is an example. Suppose NASDAQ's quote is 1000 shares offered at $22.00. There also are 100000 shares offered at $22.01. The NASDAQ quote offer is $22.00x1000. AMEX receives a 100000 share market buy order. AMEX is only required to send 1000 shares to NASDAQ for $22.00.

AMEX may ignore the order at $22.01. If there are fewer than 99000 shares offered on AMEX, then the stock will trade up all the way to the circuit breaker level. This forces NASDAQ to also halt the stock. Even though NASDAQ had plenty of liquidity, the trade on AMEX forces NASDAQ to also halt trading.

Technically, AMEX didn't break the rules. The rules are defective. The large exchanges lobbied for this rule, "only top of book gets trade-through protection", to discourage people from sending their orders to small ECNs.

A malicious trader could exploit this rule. If you send a large order to an ECN with a thin market, then you can trigger the circuit breaker.

Traders with large orders usually break them into small pieces. They usually use limit orders. It seems suspicious that someone sent a large market order to AMEX but not also to NASDAQ. Did someone maliciously send a large order to AMEX to force a halt in CSCO?

I don't know what software AMEX uses to trade CSCO. There probably aren't "liquidity refreshment points" like on the NYSE. Does someone have "market maker" status on AMEX for CSCO? If yes, they should be fined for "failing to maintain an orderly market". Even ECNs sometimes have market makers. Some traders register as "market makers" because market makers get preferred margin status. These traders publish infamous "stub quotes" of $0.01 and $99999. That satisfies the technical obligation to quote, but the SEC is supposed to be cracking down on that.

AMEX didn't break the rules. The rules are defective. What are some possible reforms?

One possibility is that the new circuit breaker rule could be enforced on a per-exchange basis, rather than globally. It seemed silly that AMEX was able to force NASDAQ to halt trading.

One possibility is to give trade-through protection for *ALL* orders and not just the top of book. The large exchanges would object. There would a "swamped with data" problem. Keeping track of just the quote is easier than keeping track of the full order book.

Another possibility is to give trade-through protection at various points. The exchange publishes the quote, the total number of shares within $0.05 of the quote, and the total number of shares within $1 of the quote. Trade-through protection is provided at each point.

That would be a compromise between using the full order book and just the top of book. The current system is unfair, when someone places a large limit book order $0.01 away from the quote. Other exchanges can just trade through it.

The current system is also unfair to "reserve" orders. For a "reserve" order, you display only a couple hundred shares, but the rest of the order is kept on the exhange's book. Other exchanges can "trade through" the reserve order. One of my coworkers observed "Only fools use reserve orders. They're too exploitable."

The stock market is one big scam. Physical gold and silver is almost definitely a better long-term investment than State paper. It's still interesting to study logical contradictions in the way the stock market operates.