dustrials decline by 10 percent before 2 p.m., the New York Stock Ex-
change will declare a one-hour trading halt.^5 If the decline is 20 percent,
a two-hour halt will be declared, and if the Dow declines by 30 percent,
the NYSE will close for the day.^6 Futures trading will halt when the New
York Stock Exchange is closed.^7
The rationale behind these measures is that halting trading gives
investors time to reassess the situation and formulate their strategy
based on rapidly changing prices. This time-out could bring buyers into
the market and help market makers maintain a liquid market.
The argument against halts is that they increase volatility by dis-
couraging short-term traders from buying when prices fall sharply since
they might be prevented from unwinding their position if trading is sub-
sequently halted. This sometimes leads to an acceleration of price de-
clines toward the price limits, thereby increasing short-term volatility, as
occurred when prices fell to the limits on October 27, 1997.^8THE NATURE OF MARKET VOLATILITY
Although most investors express a strong distaste for market fluctua-
tions, volatility must be accepted to reap the superior returns offered by
stocks. For risk is the essence of above-average returns: investors cannot
make any more than the risk-free rate of return unless there is some pos-
sibility that they can make less.
While the volatility of the stock market deters many investors, it
fascinates others. The ability to monitor a position on a minute-by-
minute basis fulfills the need of many to quickly validate their judg-
ment. For many the stock market is truly the world’s largest casino.
Yet this ability to know exactly how much one is worth at any given
moment can also provoke anxiety. Many investors do not like the instan-
taneous verdict of the financial market. Some retreat into investmentsCHAPTER 16 Market Volatility 277
(^5) If the decline occurs between 2:00 and 2:30 p.m., the halt is one-half hour. After 2:30 p.m., there is
no trading halt.
(^6) These percentage changes are converted into points in the Dow Industrials and adjusted once each
quarter. See http://www.nyse.com/press/circuit_breakers.html.
(^7) These limits were established in 1998. Previously the New York Stock Exchange suspended trad-
ing for one-half hour when the Dow fell by 350 points and closed the exchange when the Dow fell
by 550 points. Both of these halts were triggered on October 27, 1997, when the Dow Industrials fell
by 554 points. Because of intense criticism of these closings, the NYSE sharply widened the limits to
keep trading open. The new trading limits for closing the exchange have never yet been breached.
(^8) When the markets reopened after the 350-point limit was reached, traders were so anxious to exit
that the 550-point limit was reached in a matter of minutes.