Comment by seanhunter | Hacker News Reader

Comment by seanhunter | Hacker News Reader

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Contrary to what this article and other news sources seem to think, the purpose of "circuit breakers" (usually called intraday volatility breaks actually) is not to stop anyone from losing money or even to stop price falls from happening. It's to get to a functioning market with a market price that is reflective of the consensus opinion on available information as efficiently as possible without too much thrashing around.

So what they actually do is not "suspend trading" as is often stated, but suspend order matching. Orders can be placed in the book and are matched at the end of the suspension via an auction process (all the buys and sells that have price limits such that they can be matched off) are matched at the end of the suspension (usually at a single auction price print) and then continuous trading resumes.

This is essentially the exchange pausing "exchange time" so everyone can position and then resuming it again, and is exactly the same matching process that happens at the beginning and end of each trading day (and iirc after lunch in Japan) to help the market price reflect the consensus of opinion of the information that came out overnight while markets where closed.

There is a reasonable line of thinking that continuous trading is somewhat overrated and some research advocates for matching to be done entirely through auctions. So say for instance you have 1 auction per minute throughout the day.

I almost understand this, but not quite. The reason is likely that I lack the prerequisite understanding of what constitutes an order, how it's different from a limit order, and so on. Either way, I would like to understand it better because they way you put it makes it sound rather elegant.

This feels like something that could be very intuitively explained with visuals. Does anyone know of such a visual explanation of this?

Good question, but I haven't seen any.

The core concept is that there are a bunch of folks that more or less promise to either post bids (promises to buy) or offers (promises to sell) continuously, and for that promise they (sometimes) get special treatment as 'market makers.'

In an orderly market, there are both bids and offers for every instrument.

A market maker (or really any market participant) desire to participate in the market is a function of a) the rest of their portfolio (whether they are net 'long' or net 'short') and b) their expectations of when and at what price they can unwind the trade if they get 'hit' on their bid (aka someone sells to them at their posted price) or 'lifted' on their offer (aka someone buys from them).

When markets are moving 5-6% an hour, it becomes almost impossible to have any certainty on a) what the rest of your portfolio really looks like and b) when and at what price you might be able to unwind a particular trade.

This results in market makers (and HFT, and other market participants) basically exiting the market.

When people say the 'bid-offer spread is wide' this is usually what they are referring to. All the usual players basically take a step back and say 'too rich for my blood' and then you have wide markets, and 'risk premiums' for assets all over the place.

Circuit breakers are an attempt to slow time down to give people a chance to understand their portfolios better, and hence return to the market. Wide bid-offers represent highly profitable market opportunities, if the market is orderly.

When it's not, you get stuff like an ETF on US government bonds trading as a steep discount to the 'intrinsic value' of the underlying bond portfolio.

Aka chaos.

https://ycharts.com/companies/TLT/discount_or_premium_to_nav

The Dude, ladies and gentlemen. Very nicely said.

Yes, pdf page 50 of [1] has a graph with a thoroughly worked example.

[1] http://people.stern.nyu.edu/jhasbrou/TeachingMaterials/STPPm...

The terms "limit order" and "market order" are more than a little bit dated. A limit order is just an order to buy or sell at a specific price or better. It's like going on e-bay and bidding at a specific price, you may or may not get it if there is no one to sell at that price. A market order is to buy or sell right now at the market price no matter what. You may get a terrible price, but you will get the deal done.

So let's say you are looking to buy a stock. A limit order puts your bid price on the market and someone can come along and sell it to you at that price, but only after all the higher bids and all the bids at the same price that were entered before yours were executed.

The other option is to try to pay the asking price of someone who is trying to sell the stock. Let's say you see an ask at $80.00 and you are willing to pay that price so you put in a market order to buy. But someone could see your order and "front-run" you by buying up all the $80.00 asks and relisting at a higher price so you get stuck with it at that new higher price.

The safer option is to try to match that $80.00 ask with a limit order of your own at the same price, but there is a risk that it might not go through if someone beats you to it.

Think of an order like swiping on tinder. If both sides swipe (are willing to trade at a given level) they go on a date (the buyer's order is "matched" against the seller's and there is a trade).

A vol break is like everyone is still able to swipe on tinder but the dating is going to happen in one big bang (pardon the pun) when the market resumes.

If you have access to a trading platform (try one of the crypto exchanges, they usually have free data), you can try and watch an order book for a few minutes. It’s quite intuitive.

Investopedia and Wikipedia can explain the different order types.

How does the auction process work? It's not obvious to me.

I used to work at a non-US exchange, and I can tell you that the exact answer to your question must be in that particular exchange’s rules, or in the SEC filings somewhere.

In my market, the “auction” was just a period where the answer to the question “at what price do we clear the most volume currently sitting in the order book?” was being calculated by the computer.

edit:

“Isn’t that just the price where the best bid matches the best ask?”

No, because matching stops for a little while before an auction. Also, you can place some orders that will only participate in the auction.

So your order book might have a whole lot of bids at different prices encroaching into the offer side (or vice versa). Unlike during continuous trading where I don’t think bids can cross into offers (because they’d be matched and removed).

The job of our auction computer was to figure out which of those price levels would remove the most volume from the book.

There are several options.

I think you'd line up all the buy orders by descending price, and line up all the sell orders by ascending price. Then there are three possibilities: the buy orders are exhausted, the sell orders are exhausted, or there are enough of each that their prices cross an equilibrium point.

In the latter case, you set the price at the crossing point, and clear all trades that you can at that price.

If the buys are exhausted, you set the price at the sell which clear it. And if the sells are exhausted, you set the price at the buy that will clear it.

It would, under such a system, be advantageous to always have some buys or sells put in that you don't expect to clear, but would produce profitable trades in case of sudden market moves in your favor.

In the past, that function would have been filled by the "market maker" trader.

The quote that follows is from a once-popular proposal for batch auctions that was essentially nixed by incumbents that profit from complexity in the existing market structure. You may want to check out pdf page 50 of [2] for a detailed description of the demand curves described in the quote.

"During the batch interval (e.g. 1 second), traders submit bids and asks as price-quantity pairs. At the conculsion of each batch interval, the exchange 'batches' all of the recieved orders and computes the market-level supply and demand curves. If supply and demand intersect, then all transactions occur at the same market-clearing price."

The demand curves can be degenerate, which means we have to address two edge cases: "Bids and asks of exactly the market-clearing price may get rationed (pro-rata). If there is a range of market-clearing prices, choose the midpoint"

[1] https://www.cftc.gov/sites/default/files/idc/groups/public/@... [2] http://people.stern.nyu.edu/jhasbrou/TeachingMaterials/STPPm...

Here is one, programmer centric, answer: https://falconair.github.io/2015/01/05/financial-exchange.ht...

Your comment ignores the dimension of the market that is volume and only focuses on price.

If you hold inventory, you might be able to sell one unit at $x, but the buyer willing to buy the next 99 units may only be willing to offer a lower price.

The notion of a "market price" for a stock is misleading in the same way. Price represents consensus, but it is only the most shallow consensus, as many participants would not transact that price but would instead offer a worse price. Liquidity is the notion of how much the price for large volumes differs from the price for smaller ones.

Liquidity is arguably the more important concept, and so artificially batching transactions into less frequent time slots reduces liquidity and thus increases risk.

Circuit breakers, like many finance regulations, are intended to address the emotion-driven aspect of prices as perceived by humans, but should not be necessary as trading becomes more algorithmic and less superstitious.

Circuit breakers are, in effect, a clove of garlic worn around the neck of animals who are better suited to cheering on football clubs than they are to executing abstract strategies.

> Circuit breakers, like many finance regulations, are intended to address the emotion-driven aspect of prices as perceived by humans, but should not be necessary as trading becomes more algorithmic and less superstitious.

I was under the impression that algorithms were created by humans.

They are, but most exploit profit opportunities introduced into market prices by human actors. If humans were rational, there would be just as many people betting against stocks as betting on them. The idea that upward price movement is always good is also misleading. A price can be irrationally too high, so corrections are good. Most of the conventional wisdom (and typical lexicon) about markets is laden with superstition and bias.

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