Pity regulators. Well, not so much perhaps.
When markets are volatile, especially when they’re going down, a notion develops that ‘authorities should ‘do’ something’ and governments are often persuaded to step in. In many cases this has meant to either halt trading or slow it down.
The academic literature is divided on whether this is a good idea or not and analysis of past events is inconclusive. Adding to this work the paper today isolates two days in 2016 when markets were puking in China and from this study the results are clear. Circuit breakers applied at that time made matters (at least in these instances) worse.
Then markets had to observe (rules have been changed since) a 15-minute cooling off trading halt if a key index, the CSI 300 in this case, dropped by 5%. If weakness persisted and a 7% decline occurred markets were shut for the rest of the day. Practitioners can already guess what happened next!
A ‘magnetic effect’ was observed on both study days (January 4th and January 7th) i.e. stocks raced to lows when it seemed the circuit breakers were likely to be triggered. So, rather than steadying up a market they resulted in an intensified sell-off which in turn probably led to self sustaining feedback loop of investor lack-of-confidence.
China seems to have learned a lesson but other jurisdictions are still keen to tinker with falling prices. What this research shows is that stocks likely to suffer an accelerated fall in such a scenario are those that: a) had better past returns, b) lower liquidity and c) higher trading leverage.
The real value for investors from this piece is the observation that stocks that suffer most from the magnetic attraction to lock are precisely those who recover most when the flap is over. If you can keep your head when all about you are losing theirs, there’s the smart trade.
You can access the work in full via the following link Why Circuit Breakers Don’t Work, Sometimes.
Happy Sunday.