Explaining the NYSE’s “Rule 48”

August 26th, 2015 by

chiropractor

Anyone following the stock markets too closely this month is suffering from a serious case of whiplash. There’s a six-month wait to see a chiropractor or orthopedic surgeon anywhere in the country with all the traders, brokers, and investors lining up to have their necks fixed.

You can almost imagine everyone on the trading floor of the New York Stock Exchange in neck braces after the volatile swings for equities, especially this week. The undulations aren’t limited to U.S. exchanges, either; global chiropractic offices have never been so flush with patients.

stock exchange

The Dow Jones and S&P 500 took market-watchers on quite a roller coaster ride in the first two days of this week alone. On Monday, the Dow sank 1,000 points at the opening bell before a late rally halved those losses. The following trading session followed the opposite path: after opening some 3% in the green, the U.S. indices plunged in the afternoon to close in negative territory. This has prompted the NYSE to invoke “Rule 48” for the third consecutive day on Wednesday.

What the heck is this mysterious-sounding “Rule 48”?

Rule 48: An Emergency Measure

48

Not only is Rule 48 rarely invoked, but it is also rather new. It was approved by the SEC in December of 2007 and has been used a handful of times since then. The measure is used to counteract “extreme market volatility” by allowing trading to open even before the normal protocol of announcing stock prices. The idea behind the rule is that amid high volatility that is expected to have a “Floor-wide impact,” the designated market makers who distribute price indications need to circumvent the requirement to have stock prices approved before trading begins; otherwise, too much price action will be happening too fast for them to reasonably approve those pre-trading prices.

Essentially, the rule allows trading to open more quickly and possibly avoid a cascade of volatility that begets more volatility. In the few times the rule has been used, it frequently follows a suspension or halt in trading to prevent such a domino effect.

What of Free Markets?

free_market

Between Rule 48 and the use of circuit breakers on the exchange in the event that trading is halted, one is left to wonder whether the stock exchanges truly represent a free market at all. If there are artificial barriers in place that prevent free movement of stock prices, how is this any different from government-imposed price floors and ceilings, such as the widely-criticized 10% daily limit up or down that China uses for shares traded on the Shanghai Exchange.

What if somebody is bearish on equities and opens a series of short positions, and The Powers That Be intervene to prop up the markets and protect them from further losses? It would cut into their potential profits, and maybe even ruin the trade altogether. It’s not as if the NYSE steps in and takes this same action when a share is on its way up, so why should it be any different in the other direction?

If stocks are supposed to be part of a free market, it stands to reason that they ought to function like one.