Computer Trading Is Eyed

Debate Turns to Absence of Circuit Breakers, Market Makers as Mystery Plunge Is Probed.

By TOM LAURICELLA, SCOTT PATTERSON And CAROLYN CUI

Traders parsing the mystery of Thursday's stomach-churning stock-market plunge are focusing on whether rapid-fire computer trading, coupled with the market's complex trading systems, triggered a free fall that appears to have begun with an order to sell a single stock.

A big order to sell Procter & Gamble Co. shares came a little after 2:40 p.m., when the stock market was already jittery over turmoil in Greece. Minutes later, the market plunged, ultimately declining nearly 1000 points before rebounding rapidly.

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.The sell order was sent to the New York Stock Exchange, where it caused a log-jam in trading. Suddenly, P&G shares, among the market's most stable, fell about 35%.

It's not clear precisely how the P&G trade affected other securities. But the tumbling blue-chip stock helped drag down the Dow Jones index. Traders believe the big drop in P&G was picked up by computer models, which set off a chain reaction of selling in other stocks.

The violent fall has prompted an examination of the limitations of existing market "circuit breakers" and exposed weaknesses brought about by the changes in the character of modern stock markets, where most trading takes place at high speed between computers, rather than directly between human brokers.

At a minimum, traders said, the selloff shows that regulatory oversight of stock trading has not kept up with the changing nature of trading.

"There's no mechanism in the current system to stop an error from crushing a stock," said Dan Mathisson, head of electronic trading at Credit Suisse. "The regulators will need to explore restricting the use of market orders, or adding some type of circuit breakers."

Over the past two decades, stock trading has gone from a relatively transparent network of human "market makers" executing buy and sell orders at a handful of exchanges to an almost entirely computer-driven system fragmented among dozens of players. And regulators don't have the ability to directly monitor many of these new players.

Thursday's trading "clearly exposed the flaws in the current system," said William O'Brien, chief executive of Direct Edge, an electronic exchange. "We need to learn from this."

President Barack Obama said regulators "are evaluating this closely with a concern for protecting investors and preventing this from happening again." A House subcommittee set a hearing for Tuesday to investigate.

In a joint statement, the Securities and Exchange Commission and the Commodity Futures Trading Commission said: "Thursday's unusual trading activity included extreme volatility for a number of individual securities. This is inconsistent with the effective functioning of our capital markets and we will make whatever structural or other changes are needed."

A review of trading logs and interviews with traders suggests an outline of how a large but somewhat routine selloff spiraled out of control.

For a good part of the day, markets were down on worries about debt woes in Europe and unrest in Greece.

Shortly after 2 p.m., traders on the floor of the NYSE say, they noticed some wild moves in currency markets, and gold was ticking up. Stocks fell further.

Around 2:40 p.m., with the Dow Industrials down about 500 points, a big high-speed trading firm, Tradebot Systems Inc., stopped trading to limit its losses. Other high-speed firms also pulled back. These firms typically buy and sell when other investors need to trade, so their withdrawal could have primed the market for a fall.

Around the same time, the big P&G sell order hit the NYSE floor. It is not clear where the sell order came from and how big the order was. It overwhelmed available buy orders, traders say.

Because that order came amid the market selloff, a NYSE system kicked in that's designed to slow trading when there's a big move in a stock's price or trading volume. That so-called liquidity replenishment point system stopped the NYSE's electronic trading in some stocks, down-shifting into "slow" mode.

The system is supposed to allow designated market makers—human traders who work on the floor—to help bring order to the market. These traders are required to step in and buy or sell stocks when there are no other investors willing to make the trades.

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..Starting at 2:45 and 52 seconds and continuing for nearly two minutes—an eternity in markets where millions of shares trade every second—no P&G trades were reported by NYSE. For about 80 seconds, not a single share of P&G stock traded through the Big Board.

Sell orders continued to flood into the NYSE. When the orders couldn't be filled, they spilled into other electronic trading venues.

That created an overload of sell orders and caused temporary divergences in prices between stocks on the NYSE and other exchanges. Essentially, there were no buyers for many stocks, which allowed their prices to fall until a trade was done, in some cases to 1 cent.

During that time, P&G declined 35%, then began to rebound. At 2:47 and 42 seconds, the NYSE reported a new P&G trade at $56.27, just below where the stock was changing hands before the trading halt.

Meanwhile, the broad market was falling more than 100 points a minute.

"We were here and didn't know what happened out there," said Doreen M. Mogavero, president of Mogavero, Lee & Co., a floor broker. "We thought something horrific happened."

Some traders say one culprit for the quick downdraft might have been a type of trade called an "intermarket sweep order," or ISO. ISOs, which some studies say account for nearly half of all trades, send trades to whatever exchange that has the best price. The order can remain there until it is filled—even if that means the price falls to near zero.

A large number of stocks that plunged dramatically Thursday were ISO orders in which there were no apparent buyers, data shows.

Shares of consulting firm Accenture PLC fell from $41 at 2:30 p.m. to $32.62 at 2:47:46 when a trade was routed through NYSE Arca Exchange. Seconds later, at 2:47:50 p.m. an ISO trade cleared through Nasdaq at $5.54. Moments later, an ISO trade went through on Nasdaq at $3.04. The shares traded at a penny at 2:47:53 p.m.

—Matt Phillips and Donna Kardos Yesalavich contributed to this article.
Write to Tom Lauricella at tom.lauricella@wsj.com, Scott Patterson at scott.patterson@wsj.com and Carolyn Cui at carolyn.cui@wsj.com