Perspective on Trading Pauses

On Friday morning I was driving to Camp Nockamixon, in Kintnersville, Pennsylvania, to pick up my Numbers 2 and 3 from their karate camp (incidentally, they were both promoted, and my Number 2 was actually promoted to black belt!). I was listening to Bloomberg Radio on the way, tuning in to the volatility, and the numerous references to high frequency trading, and its effect on the recent market action. My mind wandered through many minefields, in trying to work (at least for me) a solution to making our market structure healthy again.

My brain began to hurt. I slowed myself down, and got off I78 and onto some back roads I knew that were real pretty. What the heck right? I had the time. While driving on these roads I started thinking about the attempts at “market protection” enacted thus far (single stock circuit breakers, short sale rules, and a proposed Limit Up Limit Down (LULD) rule that will likely replace the single stock circuit breakers currently in use.

It occurred to me, that there were no shortage of high frequency trading firms, lobbying groups, brokerages, dark pools, and exchanges who were debating whether trading pauses should a) even exist, b) be 5 seconds long, or c) be 15 seconds long. No one was advocating that there should be trading pauses of 5 minutes, or perhaps even 15 minutes. As I drove with my windows down, smelling country air at 30 mph, it hit me why they all want trading to be continuous:

High Frequency Traders (and the plethora of exchanges, brokerages, dark pools, and latency consultants catering to them) only understand how to value an asset relative to some data point immediately near. HFT knows that CSCO is worth $15.08 because another order was about to take the $15.08 offer. HFT knows that QCOM is worth $46.50 because it just got paid a rebate to buy at $46.50 from NYSE, and is about to sell it at $46.50 on YBAT for another rebate.

When trading pauses, human beings take time to think, calm down, get their bearings, and then make decisions based less on emotion and more on logic and rationality.

When trading pauses, HFT programs have no idea what to do. Was the pause due to a declaration of world peace? Was the pause due to the unfolding of a terrorist plot? Has the world changed significantly for the better due to some immediate event, or worse? HFT doesn’t know. It cannot see the future (outside of the built-in systematic Latency Arbitrage of data feeds, which it pays big bucks for). And as it can’t see the future, it can’t program what the heck it should do if there is a pause. But if trading is continuous, then it always has a reference point of value: ie the next order in the pipeline, or the quote or trade 13 microseconds ago.

Given that May 6th was pretty much a case of Hot Potato Lemming High Freak, is it wise that we are considering no trading pauses? Or that we are considering trading pauses suggested to the SEC measured in seconds? Is it wise to have no speed limits? Is it wise to never stop?