Protection against extreme volatility: This is what happens when stocks are halted

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• Trading in a share may be suspended in the event of extreme price fluctuations

• There are two protective mechanisms in XETRA trading: the volatility interruption and the suspension of trading

• Complete stock market closure possible in the event of particularly extreme events

Extremely weak company figures, political developments that endanger stability, macroeconomic crises – the list of reasons for extreme stock market events is long. There are also countless examples of extreme trading activity on the stock exchanges: the terrorist attacks of September 11, 2001, the financial crisis in 2008, the flash crash in 2010, Brexit in 2016, the election of Donald Trump as president in 2016, the corona crash in 2020 and even that The Wirecard debacle of 2020 comes directly to mind for experienced stockbrokers. All of these events caused violent price fluctuations. The herd instinct is responsible for this: more and more investors then realize that their investments are suffering enormous losses and try to liquidate or reduce them as quickly as possible in order to save a certain part of their assets. So that the panicked investors do not cascade and continue to build up unchecked in their will to sell, the management of the stock exchanges may intervene and temporarily suspend the price listing. But what specific measures has Deutsche Börse developed?

Volatility interruption in XETRA trading

On the one hand, there is a flexible and less radical cushioning mechanism on XETRA, the exchange trading platform of Deutsche Börse AG based in Frankfurt: the volatility interruption. Proper stock trading is suspended and the auction switches to an auction of at least two minutes. The goal is to slow down hectic trading, which gives worried investors time to orient themselves. This can also restore liquidity.

An important advantage of the XETRA volatility interruption is that the affected security is not suspended from trading; rather, market participants can enter, change or delete their orders during the auction phase. These are then not executed automatically, but rather collected. This information is also used to calculate an indicative share price during the auction phase: In theory, this would be the price the share costs – but in reality it is not traded during the auction phase. This provides a high level of transparency for market participants, who do not have to suffer any price losses, at least in the short term. Liquidity can also be bundled in this way, since a price from many auction offers is significantly more robust and meaningful than a single price determination, which can be based on just two orders in a rapidly moving market.

Beginning and end of a volatility interruption

But when is such a volatility break triggered – and when does this auction phase end? Two price corridors are crucial for bringing about the auction phase: a statistical and a dynamic price corridor, which develop in continuous trading with the price of the security. The statistical corridor is quite wide and is set around the opening price at the start of trading – the dynamic corridor, on the other hand, is narrower and is set around the last determined share price. If one of the two corridors is exceeded during the next price determination (which is relatively rare), then a volatility interruption is carried out: “normal” trading is switched to the auction – the duration of which is not announced beforehand in order to avoid price manipulation. As a result, the auction participants do not know when exactly regular trading will resume – the minimum duration of the auction phase is two minutes.

The two types of volatility breaks

Furthermore, a distinction must be made between two types of volatility interruption. In the simple volatility interruption model, the price is determined within a single previously defined price corridor. The auction can only end and switch to regular trading if the price determined during the auction phase is within this price corridor.

In the case of the volatility interruption model with automated corridor expansion, on the other hand, several consecutive, ever-widening price corridors are used. After the minimum period of two minutes has elapsed, a check is made for each individual price corridor to see whether price determination is possible within the respective corridor. If the price determined is within the price corridor after the two-minute minimum period, the auction can be ended. If this is not the case, the auction is extended and the check is carried out again in the next price corridor after the minimum duration has expired. If all else fails and the determined price is still outside of the valid price corridor after passing through all defined price corridors, the system switches to an extended volatility interruption. In this case, it is ultimately at the discretion of the stock exchange management when a robust new price level was determined in the auction order book. Only then will you switch back to continuous trading.

Complete suspension of trading in XETRA trading

In the event of particularly extreme price fluctuations, XETRA has an even more drastic instrument at hand: the complete suspension of trading. If orderly trading in a share is jeopardized, the management of the Frankfurt Stock Exchange may decide to temporarily suspend the listing of that security. In this case – in contrast to the volatility interruption – the price is no longer calculated according to the auction principle. This usually occurs when a company makes surprising, i.e. not priced in, ad hoc announcements, especially when there is a risk of insolvency. In response, legions of investors are hitting the sell button, while even die-hard bargain hunters are showing little interest in buying. Supply then exceeds demand to such an extent that the stock plummets in a matter of seconds.

The Frankfurt Stock Exchange regards the resulting price jumps as “special circumstances in the issuer’s area” and then has a protective instrument at hand with the suspension of trading. How long the suspension of trading lasts is at the discretion of the exchange management. This usually lasts an hour, but in particularly serious cases trading in a share can be suspended for even longer. All companies listed in Frankfurt can be affected by a price suspension, the existing orders will then be deleted to protect investors. In the case of orders with a longer term in particular, it can happen that investors are not even aware of this short-term trading interruption and wonder why their orders are no longer available. A look at the order book then provides clarity.

Stock market closures in the US

In the case of particularly violent fluctuations in the overall market, all stock exchange trading can even be suspended for a certain period of time. Especially in the USA, there have been a number of much-noticed suspensions of trading (“trading halts”) of the entire capital market in the last few decades. Until 2011, the development of the traditional Dow Jones index for the New York Stock Exchange (NYSE) was the yardstick for such a serious step, since then the more broadly positioned S&P 500 has served as the indicator.

Incidentally, the last suspension of trading on the US stock exchanges was not that long ago: During the Corona crash, trading on Wall Street was suspended for 15 minutes on March 9, 2020, after the S&P 500 fell by 7 percent within a few minutes of trading starting had rushed down. As a general rule, if the S&P 500 loses more than 7 percent from the previous day’s level before 3:15 p.m. Eastern time, trading on US exchanges will halt for 15 minutes. Should the S&P 500 lose more than 20 percent, Wall Street will shut down completely for the rest of the day. Such an enormous loss, however, represents an event of the century. The only time since 1928 has the S&P 500 lost more than 20 percent in value in one day, namely on “Black Monday”, October 19, 1987. On that historic day the S&P closed a whopping 20 .47 percent below its previous day’s level.

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