What caused the stock market's wild swing?

Here are questions and (some) answers regarding what's known about the stock market's 20-minute, 600-plus-point roller-coaster ride on Thursday. The Dow closed down again on Friday.

By , Staff writer

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    A board at the New York Stock Exchange shows the Dow Jones Industrial Average finally settled Thursday at 10520.32, down 347.80 points. Earlier in the day, it plummeted 1,000 points before recouping some of that ground.
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Thursday's surreal stock market performance was like something out of "The Twilight Zone.” Call it the Twilight Exchange – a place where stock markets crash but trades didn’t happen, a place where investors watched their stocks fall to a penny a share only to find out it was all one big … mistake.

Yes, investors, in a 20-minute period Thursday afternoon the Dow Jones Industrial Average fell by more than 600 points, only to reverse itself and climb by the same amount. (On Friday, it fell another 138.89 points, closing at 10380.) But some of the exchanges have “busted” many of those Thursday trades, saying they really didn’t happen. What does this mean?

First of all, the companies that maintain the indices – Dow Jones Indexes, a member of the CME Group, and Standard & Poor’s (S&P) – say they are not planning to revise their numbers to reflect stock trades that have now been reversed.

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For example, none of the individual components of the Dow Jones Industrial Average rose or fell by 60 percent in that time period, says Sybille Reitz, a spokeswoman for the Dow Jones Indexes. “We did reflect the market at the time, but at the same time we didn’t use the pricing information that they busted.”

Most important, says Ms. Reitz, there was no need to adjust closing values because they were not affected by the decision to negate trades.

Likewise, Standard & Poor’s, which manages various indices, says it has no plans to account for the trades that did not happen.

“We don’t rewrite history,” says David Guarino, a spokesman for S&P in New York. “This is more of a question for the exchanges and product providers.”

If the whole thing has left you scratching your head, join the crowd. Here are answers to some questions about what happened.

What are the Exchanges doing to protect investors?

According to the New York Stock Exchange/ARCA, the electronic trading arm of the NYSE, many trades that took place Thursday between 2:40 p.m. and 3 p.m. in which the stock rose or fell 60 percent or more have been canceled.

So, for example, the stock price of American Tower Corp., a Boston-based company that manages broadcast tower sites, started Thursday at $39.79 a share, then dropped below $15.92 a share as the market went into its free-fall. Now, the NYSE/ARCA is negating any of those trades below $15.92, which, according to the exchange, would be 60 percent off the opening price. The company’s stock closed at $40 per share.

What are the regulators doing about this incident?

The Securities and Exchange Commission and the Commodities Futures Trade Commission are investigating the wild day. “We will make public the findings of our review along with recommendations for appropriate action,” the SEC stated on its website.

What's the leading theory about what happened?

Initial rumors were that a trader had make a mistake while keying in a sale of $16 million worth of stock, mistakenly typing $16 billion with a "b." Those rumors placed the trade as coming from Citigroup. However, Citigroup stated on Friday, "Based on our review, rumors about a trading error by Citi are unfounded. It is troubling that inaccurate and unfounded rumors were spread as far as they were."

What else might have caused the free-fall?

It's not clear yet. Theories range from cyberterrorism (someone hacked into the computers and placed fake trades) to suspicions that electronic trading got out of hand. In electronic trading, stock traders try to use computers to execute trades quickly, perhaps seeking to make a profit on small changes.

According to the Simon Graduate School of Business in Rochester, N.Y., there was a rapid-fire, two-minute selloff of 16 billion futures contracts tied to the Standard & Poor’s 500 stock index, known as E-mini S&P 500 futures.

Not the case, says the CME Group, which oversees the exchanges where the E-mini is traded. “All our markets operated properly. There was no issue with the S&P futures contracts, and there was not any unusual activity,” says Michael Shore, a spokesman for the CME Group in Chicago.

Fred Dickson, chief investment strategist at D.A. Davidson & Co. in Lake Oswego, Ore., wonders if the steep downdraft was the result of a “cascade” effect. For example, the market on Thursday was having a bad day trying to absorb the implications of a sharp drop in the value of the euro. On the NYSE, specialists had started to institute “shock absorbers,” whereby they tried to slow trading by instituting an auction process. However, it’s possible the slower markets drove some of the traders into the electronic markets, which have much less liquidity, says Mr. Dickson.

“All of a sudden there were all sellers and no buyers,” he reasons. “We may be seeing the penalty for not having any human intervention to slow things down and get it back to an orderly marketplace.”

Are there implications from the day?

The wild ride indicates that the trading system failed, says John Broussard, an associate professor of finance at Rutgers University's School of Business in Camden, N.J. “There was a system failure somewhere," he says, "and I’m not sure where it was.”

It’s imperative that the exchanges restore confidence in their integrity, says Dickson. Moreover, Congress should hold hearings to determine what happened, he says. He anticipates that the financial regulatory reform legislation currently being debated in Congress may incorporate some changes to protect investors from extreme days in the markets. He adds, “The legal ramifications are off the charts.”

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