The New York Stock Exchange yesterday put temporary restrictions on computer-directed program trading whenever the Dow Jones industrial average moves up or down by 75 points in a single day.
The restrictions, which take effect today and will last through next Friday as a test, are designed to boost investor confidence by diminishing the wild swings in prices that climaxed in the 508-point plunge in the Dow on Oct. 19. The presidential commission that studied the stock market collapse put much of the blame for the fall on computer-directed selling by a handful of large institutional investors.
"The NYSE, after consulting with its major member firms, has requested that if the Dow Jones industrial average should move 75 points or more -- up or down from the previous day's close -- that all member firms refrain from using the NYSE SuperDot system to execute program trading orders for the remainder of that day," said NYSE Vice President Richard Torrenzano.
A review of the impact of the temporary restrictions, Torrenzano said, "will assist in discussions on intraday volatility at the next NYSE board meeting."
The NYSE SuperDot is an automated order system that allows traders to buy or sell hundreds of stocks simultaneously in connection with a program trading strategy known as index arbitrage. The rapid execution of orders is a critical element in index arbitrage, as traders seek to profit on the momentary price discrepancy between hundreds of individual stocks and stock index futures contracts, such as the Standard & Poor's 500 futures index.
The S&P 500 futures index, which represents a broad stock market average, is traded on the Chicago Mercantile Exchange. In index arbitrage, if the S&P 500 futures index trades momentarily at a lower price than the 500 individual stocks that make up the index, traders could lock in a profit by buying the futures index and selling the stocks.
But if several large institutions use the NYSE SuperDot system to sell stocks simultaneously, prices of hundreds of stocks can decline sharply, scaring investors and discouraging traders using more traditional strategies.
The presidential commission headed by investment banker Nicholas F. Brady criticized the NYSE's decision to suspend use of the SuperDot system for program trading in October, arguing that the move exacerbated the gap between stock prices in New York and futures prices in Chicago. The commission suggested in its report that the SuperDot system ought to favor individual investors over program traders when markets are volatile.
The commission also called for greater coordination between New York and Chicago of "circuit breaker" mechanisms, such as price limits and trading halts. But in recent days, Chicago markets have announced maximum allowable daily price moves without coordinating those limits with New York. The daily price limit on the S&P 500 futures index is equivalent to more than 200 points up or down in the Dow Jones industrial average.
Some traders who declined to be identified said the NYSE move would exacerbate price gaps between the stocks and futures markets and add to volatility. But local traders and high-ranking New York executives praised the NYSE step.
"I think it is a constructive experiment," said Goldman, Sachs & Co. partner Robert Mnuchin.
"I think it is an excellent move because I think this volatility has brought up a whole lot of nervous and unsettled situations," said Carroll Ownes, senior vice president and trader at Washington's Johnston, Lemon & Co.
Capital Guardian Trust Co. Chairman Robert Kirby, who served on the presidential commission, said, "I'm really delighted. This is a first tiny step but it is sure a step in the right direction."