Reasons for Stock Market Problems
The stock market is a large and complex entity with many players. Problems easily erupt in the stock market, and often these force new regulatory policies and renewed scrutiny of stock market practices. But because of its size and reach and the evolving technology that governs market actions, stock market problems will always be inevitable. It is wise for investors to know which factors contribute to market swings and inefficiencies.
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Decentralization
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As widespread electronic transactions account for more and more of stock market trading, this lack of any central clearing house or real-time oversight can wreak havoc on the markets. On May 6, 2010, the stock market experienced its largest one-day decline in history, all over the course of just a few minutes. The seemingly random drop, which reversed almost immediately, left government agencies and regulators confused about its cause. One likely reason for this stock market event is the decentralization of stock market order execution. The New York Stock Exchange followed its own policy to temporarily slow or halt trading on excessively volatile stocks until the market can catch its breath. But in the modern era, trades that cannot execute in one arena are instantly routed to another. Market makers in other areas of the industry did not have any similar policy in place. This allowed stock transactions to continue, even though the governing exchange would not fill orders. This led to a critical imbalance in supply and demand, and the market crashed dramatically.
One month later, the Securities and Exchange Commission created new rules in an effort to remove discrepancies in market policies between different firms. But this event demonstrates the growing problem of a lagging regulatory response to the changing landscape of stock market technology.
Trading Vehicles
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Today, an investor has easy access to trading vehicles far beyond simple shares of stock. Futures, stock options, exchange traded funds known as ETFs, and currency contracts are all standard components of many regular brokerage accounts. The goal of these vehicles is to facilitate more speculative trading while streamlining exposure to entire sectors or foreign markets. However, the large volume of trading activity that flows through these products is influencing the stock market in new and potentially volatile ways. ETFs in particular now account for nearly one-third of all activity on the NYSE. The firms that manage ETFs must buy and sell real stocks to ensure their ETFs maintain an accurate reflection of the markets they track, a process called "re-balancing." This end-of-day process can force unusual price swings that are not based on actual interest in individual stocks. This can increase volatility and create a problem for the stock market.
Short Selling
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Short selling is the process of selling stock you do not already own. It lets traders profit from price declines. Over the decades, government regulators have changed the policies that short sellers must follow. The "uptick rule," which was active for much of the 20th century, then removed in 2007 but re-instated in a new form during 2010, is an example of how difficult it is to manage the potential problems caused by short selling. This rule states that you can only sell a stock short if it is actually rising in price at the moment of your trade. While little formal evidence suggests that short sellers cause major market declines, the role of short selling in the stock market is an ongoing problem for regulators and raises many ethical questions for those who practice it.
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References
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