Anatomy of a Crash

A funny thing happened on the way to the market.

Around 2:45, Boring old Proctor and Gamble–maker of toothpaste and shampoo–fell off a cliff. The stock suddenly dropped 25%, from $60 to $45/share. Since the Dow is an average, that triggered a 100-point drop in the index, and programs all over the world started buying the Dow and selling other indices.

Chaos followed. Excelon, the 30 billion dollar utility company, traded for less than a penny. Perhaps because of an errant trade, the market was staging a repeat of 1987, where technical factors lead to a full-scale meltdown.

What happened next is instructive. Stocks trade on electronic markets all the time, but on the NYSE they have human overrides. Because the stock fell below a key circuit breaker level, the exchange switched to a human auction. This came up with a price of $56, far above what was shown on other exchanges. The whole process took about 90 seconds.

The other exchanges are now debating whether to alter their errant, computer-driven prices to New York’s auction price. If I had sold stock, I sure would want them to. And buyers still scooped up P&G at a bargain level. It closed at $60.75.

The larger lesson is that the system worked. Human intelligence overrode computer automation and a market meltdown was avoided. Something to think about as we continue to debate financial reform.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

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