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Ask The Experts: Are Stock Market Glitches Something to Worry About?

Ask The Experts Stock Market Integrity

On August 22, trading in more than 2,700 NASDAQ stocks came to a screeching halt. A glitch in the system halted trading for several hours.

Rewind to May 18, when Facebook launched its much-anticipated IPO. Again, a glitch on the NASDAQ stock exchange delayed the start of trading. Even after trading began some orders didn’t get through. Traders were outraged and the IPO was pretty much a flop.

Even the New York Stock Exchange has not been immune to technical problems. On May 6, 2010 the exchange suffered what was called a “flash crash.” Due to a technical glitch, the Dow Jones Industrial Average plunged more than 1000 points in a matter of minutes, only to recover minutes later. But investors who had entered stop-loss orders – orders to sell a stock if it fell to a certain price – lost big.

Technology Rules

Technology rules everything these days, even financial markets, but when it fails there can sometimes be a big price to pay. Is this something to worry about as we go forward? Most of the experts we consulted don’t think it is.

“Personally, I am not worried about it,” said David Vang, professor of finance at the University of St. Thomas.  “The volume of dollars transacted daily is so significant that such trading platforms and exchanges have a huge incentive to fix things ASAP once things come to light.”

With the glitches so far, it has mostly been day traders and hedge funds that have taken the biggest hits. If you have a sizable stock portfolio in your retirement account, should you be concerned? Not really, says Raymond P. H. Fishe, professor of finance at the University of Richmond.

“These are mostly buy-and-hold accounts, so they have horizon’s beyond the effects of temporary platform glitches,” he said.

Restoring Confidence

Are there things the markets can do to shore up confidence? Maybe, but is that truly the right question to focus on?

“The question is really what can regulators do to restore confidence?” said Michael D. Goldberg, economics professor at the University of New Hampshire. “They need to play a much stronger role than they have.”

Bryan Routedge, associate professor of finance at Carnegie Mellon University, agrees but thinks the exchanges should all work to make trading cheaper and more efficient. When it comes to markets, he has bigger worries.

“The much larger thing to worry about, at least to me, is risk to the economic fundamentals that drive prices,” he said. “I am not pessimistic here.  I am just pointing out that ‘confidence that the market can execute trades’ is much different than ‘confidence that equity prices will rise.’”

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Bryan Routledge

Associate Professor of Finance, Carnegie Mellon University

Are you concerned about the integrity of the stock markets, in light of the latest NASDAQ glitch?

Not particularly. Glitches are relatively rare and quite transitory. NASDAQ and NYSE and other markets work hard and are quite thoughtful about the mechanisms of trade (‘market microstructure’). Over the past 30 years, trading on the markets has become much cheaper both in terms of the fees charge and the width of the bid-ask spreads.

Specifically to glitches, the AP twitter account was hacked on April 23 of this year. The false tweet about an attack triggered some to trade and prices fell. More remarkable is how fast they came back up. There were not that many trades at the lower prices (looking the S&P futures transaction data). Markets react to news quickly and almost always ‘correctly.’

Should consumers with retirement funds in equity accounts be concerned?

No to glitches. Yes to risk in general.

As I mentioned above, markets react very fast and most often quite sensibly. This is tremendously important to the economy on the whole since the stock market is a vehicle for allocating capital resources. New companies and companies with value-creating ideas need access to financing and the well-functioning market helps makes that happen. More generally, the market’s role as a ‘leading indicator’ is important for decision making. Corporations make their capital budgeting decisions aided by information inferred from markets.

Should individual investors worry? Not about glitches. But the stock market is a risky asset. The average equity return (above bonds) is about 6% per year. But the volatility is about 20% per year. That implies ranges easily from -20% to +20% over the course of a year. That is not to suggest one should not invest in stocks — but this is not the place for the entirety of your retirement money. Especially if you are thinking of retiring soon.

What can the markets do to restore confidence?

NASDAQ, NYSE, regulatory agencies should all work to make trading cheap and efficient. For the most part that is what they are doing. Periodic glitches — like the power going out at home during a summer storm — seem with sensible management infrequent and transitory. Is there are risk of a prolonged ‘outage’? I am not well informed enough to judge. However, from the one recent experience we had at that — the closure of markets around the tragedy of Sept 2001 – even prolonged trading disruption is not that worrisome to individuals.

The much larger thing to worry about, at least to me, is risk to the economic fundamentals that drive prices. I am not pessimistic here. I am just pointing out that ‘confidence that the market can execute trades’ is much different than ‘confidence that equity prices will rise.’
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David Humphrey

Fannie W. Smith Eminent Scholar in Finance, Florida State University

Are you concerned about the integrity of the stock markets, in light of the latest NASDAQ glitch?

Not concerned. Retail investors should stick to long-term investments in the stock market and elsewhere. When this occurs, the technical trading problems you note for the stock market are very minor. I don’t have any sympathy for problems faced by frequent traders since this is just, in my view, speculative and generates unneeded price variance.

Should consumers with retirement funds in equity accounts be concerned?

My reply here is the same as for the question above.

What can the markets do to restore confidence?

The issue of confidence in a short-term speculative market seems to me to be a non sequitur. Longer-term, the issue boils down to reducing speculation to enhance confidence and lower variance in this market. One way would be to raise margin requirements to 100%.
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David O. Vang

Professor of Finance, University of St. Thomas

Are you concerned about the integrity of the stock markets, in light of the latest NASDAQ glitch?

Personally I am not. The volume of dollars transacted daily is so significant that such trading platforms and exchanges have a huge incentive to fix things ASAP once things come to light. Over the years, trading exchanges have to deal with competition from other venues that would love to have their business (both on the company listing side and the trading side), and in addition there is the legal exposure should ‘glitches’ become common occurrences.

Should consumers with retirement funds in equity accounts be concerned?

This really is not a significant issue for long-term investors to be concerned about. Such funds have investment objectives that lean towards an intermediate to long-term, buy and hold strategy. So the occasional trading complication does not affect them as much as a day trader.

What can the markets do to restore confidence?

If you are talking about restoring confidence after the occasional trading glitch, there really is nothing that I could suggest that trading platforms such as NASDAQ don’t already have an incentive to fix themselves. If you are talking about the overall economic environment causing a lack of confidence, then unfortunately, the solution would be in the realm of politics. In that case, all of the classic issues will have to be addressed (1) having stable, simple tax rules that do not change every year, (2) getting a final decision on the ACA whether it is repealing it, fixing it, or at least having a knowable waiver policy, and of course, (3) getting the government on a sustainable path towards financial soundness.
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Raymond P. H. Fishe

Distinguished Professor of Finance, University of Richmond

Are you concerned about the integrity of the stock markets, in light of the latest NASDAQ glitch?

No. The trading platforms have evolved rapidly to new regulations and the demands for higher speed executions and order processing. There have glitches in the past when software is involved and there will be glitches in the future. Any worries that I have arise from coordinated strategies that overwhelm the I/O ports on these platforms, so that public dissemination of trades and prices is delayed and/or orders are not posted in a timely manner. These problems will challenge exchange operators and potentially affect the public’s confidence.

Should consumers with retirement funds in equity accounts be concerned?

No. These are mostly buy-and-hold accounts, so they have horizon’s beyond the affects of temporary platform glitches.

What can the markets do to restore confidence?

Both markets and regulators are looking these problems, mostly on a case-by-case basis, to construct solutions. The fat-finger problem can be fixed with a re-confirmation algorithm. The software bug that starts to create rapid and unplanned orders is a de-bug problem, but the issue is how to provide an incentive to find such bugs before the environment in the market place randomly stumbles on to them. Here the regulators and exchanges probably need some type of carrot-and-stick incentives; traders with flawless systems/records face a very light penalty should a mistake arise, but those with multiple cases of disruptions or bugs should face much more severe penalties.
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Michael D. Goldberg

Todd H. Crockett Professor of Economics, University of New Hampshire

Are you concerned about the integrity of the stock markets, in light of the latest NASDAQ glitch?

Yes, well-functioning financial markets are crucial for fostering dynamism in the economy. The NASDAQ glitch, like the flash crash, the concern over high-frequency trading, the manipulation of markets by banks (i.e., LIBOR, currencies) reduces markets’ ability to do their job by undermining people’s confidence in them.

Should consumers with retirement funds in equity accounts be concerned?

I see these ‘glitches’ as having short term (minutes, hours, days) effects, without influencing market’s ability to price assets over the longer-term (months and years). So consumers with retirement accounts should not be directly affected by the ‘short-term’ glitches. However, there is a very important indirect effect: to the extent that the short-term glitches undermine confidence in markets, and this reduces markets’ ability to allocate capital, the longer-term dynamism of the US economy, and therefore the value companies (and thus the value of retirement portfolios), could be reduced.

What can the markets do to restore confidence?

The question is really what can regulators do to restore confidence? They need to play a much stronger role than they have.
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Stephen J. Ciccone

Chair, Accounting and Finance Department, University of New Hampshire

Are you concerned about the integrity of the stock markets, in light of the latest NASDAQ glitch?

No. The recent glitch was only a short-lived technical problem.

Should consumers with retirement funds in equity accounts be concerned?

No. Long-term investors should not be concerned about short-term glitches. Of course, they should remain concerned about the economy, asset allocation, and other long-term issues. The glitch is more worrisome to short-term investors, such as day traders. However, computer glitches that broadly affect trading are relatively rare, and I expect any systematic problems will be alleviated by the exchange and the regulators.

What can the markets do to restore confidence?

I do not think the markets have lost confidence, at least related to computer glitches. NASDAQ trading returned to normal fairly quickly after the computer glitch was corrected.
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Brian J. Adams

Associate Dean of Graduate Programs, University of Portland

Are you concerned about the integrity of the stock markets, in light of the latest NASDAQ glitch?

No. Given the migration to greater use of technology in financial markets, the probability of disruptions (no matter how small) will be present.

Should consumers with retirement funds in equity accounts be concerned?

No. Investors saving for retirement should have a long-term focus with their investments. A three hour trading outage should not disrupt the value of their long-term holdings.

What can the markets do to restore confidence?

As with most issues that come up with financial markets, transparency and a clear communication channel.
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Michael Casey

Professor of Finance, University of Central Arkansas

Are you concerned about the integrity of the stock markets, in light of the latest NASDAQ glitch?

Whenever you increase the technical complexity of a system you have the potential to increase the frequency and duration of hardware and software glitches. However, given the high cost associated with lost trades when you have down time in the financial markets I expect the industry to spend considerable financial resources to ensure that redundant systems are in place to keep the markets open. The issues surrounding incorrect orders from Goldman Sachs are more troublesome but will also result in greater investments in technology to limit the impact of any future technology glitches. With that said I personally am not concerned about market integrity.

Should consumers with retirement funds in equity accounts be concerned?

I believe in passive investing with a long-term focus and a diversified pool of assets. Retirement funds should be placed with managers that have similar investment strategies. Therefore, if retirement monies are invested according to my philosophy any short-term glitch is irrelevant. In short, I would not be concerned.

What can the markets do to restore confidence?

The major players need to assure the investing public that they intend to invest in better technology and create mechanisms that rapidly detect problems and limit their impact. It’s in their best interest to do this in order to keep investors from losing faith in the debt and equity markets.

 
Image: photo.ua/Shutterstock

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