Can someone explain to me my why stock markets have "circuit breakers" to stop trading when markets go DOWN by N% but not when they go up by N%? Isn't that kind of playing favorites to folks playing one side of the market vs. the other?
Conversely, there is no mechanism that can push the market increasingly higher, other than hyperinflation or a collapse in, say, the bond market which might theoretically drive investors into equities. But if the bond market collapses, the world has much bigger fish to fry and the stock market will probably come down right afterwards.
The upside circuit break has very practical implications. China's current stock market was started in 1990. The general public began to paying attention to stock market around 2000. From the historical point of view, both the stock market and the general public's understanding on it are still in early stage. So the attitude on stock market is very speculative. Coincidentally, the economy in China has been undergoing stunning growth during this period, which generates a huge amount of wealth. This furthers the stock market's speculative nature. As a result, the volatility could be very high. It was not uncommon to see some stocks undergo several +/-20% changes during a week, before the upside circuit breaker was established. Its primary purpose is to curb the speculation.
Limits are subtly different from circuit breakers in that trading can continue... within the limits.
[1] http://www.cftc.gov/industryoversight/marketsurveillance/spe...
https://en.wikipedia.org/wiki/Trading_curb#China
"If the CSI 300 Index rises or falls by 5%..."
Also, when people have short positions in the equity markets they get margin calls and are forced to close out their positions by buying stock when the market rises. This would be a similar process that roymurdock mentioned but to the upside. It's called a "short squeeze."
[0] http://www.cnbc.com/2015/09/07/chinas-latest-step-to-curb-sh...
>Meanwhile, a 7 percent rise or fall in the CSI300 Index will prompt a trading halt in the Shanghai and Shenzhen stock exchanges for the rest of the day, the statement posted on the exchange's website said. Both circuit breakers will only be activated once a day.
I'm not sure what this means, given that it already specified that either circuit breaker halts trading for the rest of the day...
>The proposed mechanism will be tied to the benchmark CSI300 Index, which tracks the largest listed companies in Shanghai and Shenzhen, where a move of 5 percent in either direction from the index's previous close will trigger a 30-minute trade suspension across the country's equity indexes if the move occurs before 2.30 pm local time. After that, a 5 percent move will freeze trading until the market close at 3.00 pm.
>Meanwhile, a 7 percent rise or fall in the CSI300 Index will prompt a trading halt in the Shanghai and Shenzhen stock exchanges for the rest of the day, the statement posted on the exchange's website said. Both circuit breakers will only be activated once a day.
When you look at the history of commodities and equities trading you will see that a big chunk of the market can be held by people who don't feel they have enough visibility to understand why something is going down, and so when it goes down in an uncharacteristic way, they panic and join in the selling and that grows quickly. The "down" side is that people lose money from panic. But if the market goes up quickly people generally hold on to their stock waiting for it to go up still more, so there is no need to slow trading, it slows itself.
The apocryphal saying “financial markets are driven by two powerful emotions – greed and fear.” is fairly simple but it does capture the essence of the primary movers.
I don't think anybody has mentioned another reason: stock markets are _naturally_ "long" rather than neutral. When companies issue public offerings (e.g. an IPO), they create shares of stock from "thin air"--that is, there is a buyer who ends up long (owns stock), but nobody ends up short. However, once stocks start trading on the secondary markets, every buyer is paired with a seller. So always, the sum of all long positions exceeds the sum of all short positions. On average, everybody is happy when the stock market goes up, and everybody is sad when the stock market goes down. So it makes sense to place a speed bump on the downside only.
Compare this to derivatives (futures, options) where there are no "public offerings", and every single trade is a buyer and seller paired. There is a net balance of long and short positions at all times. Consequently, many derivatives have limits in both directions. Note that some derivatives have no limits (whoa scary), and many equity index derivatives carry over the one-sided limit. S&P 500 futures, I believe, have two-sided limits outside of core US market hours, but only a downside limit once the stock market opens.
We also often see things like bans on shorting stocks. Again a bias to being long equities.
When I was trading corn and soy, I've seen a few limit up/down days myself, but thankfully never caught in them.
A more subtle ceiling is why companies split their stock: a huge price per share distorts the market. Imagine if Costco were the only place you could buy butter, but they sell it in five-pound packs. Individuals might not buy any.
"when it goes up or down by 7%, it usually means that sharp volatility has taken place in the market, which is likely to face the extreme systemic risks. Therefore, the market needs more time to calm down so as to prevent the spreading panic from intensifying the market fluctuations."
http://english.sse.com.cn/aboutsse/news/c/c_20151207_4019977...
"Meanwhile, a 7 percent rise or fall in the CSI300 Index will prompt a trading halt in the Shanghai and Shenzhen stock exchanges for the rest of the day"
http://www.cnbc.com/2015/09/07/chinas-latest-step-to-curb-sh...
Also, I very much doubt China is going to start disappearing traders who make their stock market go up 5% like they're doing now :
http://www.ibtimes.co.uk/china-arrests-197-authorities-pin-b...
i.e. if I have a $1 million dollar position, I have the power to try to sell $1 million dollars worth of stock, but I can only buy another $1 million dollars if I have that amount liquid in the bank or I have enough credit to borrow $1 million to double my position.
Upward movements are attenuated (or accelerated) by the quantity and velocity of credit available in the market.
If something serious is happening in the economy, it seems unfair to me to simply halt trading, forcing everyone who has stock to be stuck with exactly what they've got, leaving them unable to sell and other people unable to buy. If people want to trade their property, why prevent them?
For example, there might be a rumor (perhaps started by an unethical competitor or market manipulator) that Company X was just caught in some sort of scandal. Those who panic most and sell soonest might get a better price than those who take the time to find out the truth, providing a potentially serious financial motivation to panic. Panic, and rapidly falling prices on something large, can cause sales of other assets as a hedge against others selling assets as a hedge...and it can cascade out of all proportion to what is actually happening in the economy.
The idea of the circuit breaker is that it stops everyone from trading but doesn't stop the news or analysis. Let everyone catch up on the news--what's really going on in these companies and their markets--and then let people trade based on facts, not panic. After more is known, and known by all, those who still want to trade will be allowed to do so.
Whether it really works out that way in practice is a different question. A circuit breaker that doesn't stop trading long enough for anyone to learn anything beyond additional rumors might merely allow the panic more time to spread, but the above is the usual explanation given by those who make the policies.