Two times in the past week, circuit breakers halted market trading for 15 minutes. But, what is a circuit breaker and why are they used? And, how are they relevant to your ETF investments? We explore this topic of circuit breakers and ETFs more here.
What is a circuit breaker and why are they used?
Circuit breakers are common in homes, apartments, or any dwelling that uses electricity. They stop the flow of electricity and protect the circuit from damage. Analogously, financial markets use circuit breakers to protect investors from excessive selling when few buyers are available.
“It’s working as it’s designed to function so that the market can absorb what news was out over night, how investors are reacting so they can make decisions and everyone gets a chance to see what’s happening.”
New York Stock Exchange President Stacey Cunningham
The NYSE has three levels of circuit breakers used to stop trading, based on the S&P 500 index.
The NYSE triggered Level 1 circuit breakers on Monday and Thursday of this past week.
What about ETFs and Circuit Breakers?
Since ETFs also trade on financial exchanges, trading ETFs stops when a circuit breaker trigger occurs. When markets reopened this week after their 15 minute halts, the circuit breaker showed its worth by reducing market volatility. Our opinion at ETFMathGuy is to avoid trading during times of like these, due to market volatility increasing the bid-ask spread.
As you can see in the image above, trading ETFs are more expensive due to the impact of the coronavirus. This image shows daily spreads over the last 12 months for the highly liquid iShare Core S&P 500 ETF. Recently, spreads increased by a factor of 4-5 times. Investors would be well served to think about their long term stock allocation strategy and risk tolerance. If possible, avoid selling at times like these to avoid these higher transaction costs. But, if you must trade, avoid selling immediately after markets re-open. Give the the price discovery process a chance to catch up.
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