The European Securities and Markets Regulator (ESMA) has determined that circuit breakers can have significant impact on market volatility.
These are mechanisms that monitor the market continuously and trigger a trading halt as soon as the price of an individual security or an index falls below or rises above a predetermined level.
Another common word for circuit breakers is trading halts.
In a new study, it examined a sample of 10,000 financial instruments traded between April 1, 2016 and December 31 the same year where circuit breakers were used.
ESMA found that trigging circuit breakers significantly lowered price volatility, while bid-ask spreads widen and the price discovery process is not negatively affected by the circuit breakers.
In other words, the tools can be used to dramatically reduce the risk of sudden and drastic price swings in financial markets that, in turn, can produce market instability.
ESMA highlights that this could be a useful tool as several events – such as the 2010 flash crash and the market movements in the US in 2015 – have shown just how important of ensuring orderly functioning of trading venues in situations of large and sudden market price movements is.
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