Millions of Americans froze in panic last Thursday when the stock market declined nearly 1,000 points in a matter of minutes. This was the largest one-day decline in the history of the New York Stock Exchange. Most of the time, market declines are triggered by economic fundamentals: a company has a bad earnings report, there's a war that might affect the price of oil, or the Chairman of the Federal Reserve Board decides to raise interest rates. In this case, there was no such logic behind the activity. Most believe it was simply a trading error.

The error could have been someone inputting a billion shares instead of a million, or a price of $1,000 dollars per share when they really meant $100. Either way, the mistake triggered a chain of events that caused the entire market to panic and for federal regulators to call for more action and new rules for trading on the stock exchange. Most of the rules are going to involve electronic trading and computer programs designed to execute trades based on certain triggers. For example, a company may set a computer program to automatically sell shares of a certain company's stock when the price drops more than 2 percent in one day. So, if someone makes a mistake and issues a larger sell order than expected, this could cause the price to drop, leading other companies (and their computers) to sell their shares as well. All this selling can cause the price of the company to keep dropping, like a herd of buffalo running out into the wild.


"We need to work out a common consensus as to how markets react when stock prices start to plunge in very short time periods," said Richard G. Ketchum, the chief executive of the Financial Industry Regulatory Authority.

One complication that Ketchum must face is that the "stock market" is not one market. There are actually 50 organized markets across the United States where stocks can be bought and sold, and most computer programs send your order to the market offering the best price for its customers. This creates a fragmentation in stock trading that leads to disorder and chaos if there are too many sell orders and not enough buyers. One example is when the shares for Proctor & Gamble fell quickly, and then rose right back to their original levels.

Some markets use "circuit breakers" as a solution to this problem. These are mechanisms designed to automatically stop all trading in any security that drops or rises too fast all at once. These programs make sense if they are applied uniformly, or to just one market. But the issue on Thursday was that when the New York Stock Exchange applied its circuit breakers, the computers automatically took the trades to other markets. These markets, seeing that there were fewer buyers than sellers, kept offering the shares at lower and lower prices to induce investors to buy. That is what led to the unprecedented price decline.

The Securities and Exchange Commission will need to get involved to regulate trading across all markets, not just a select few. If they do not, the economic results could be disastrous.

Lawrence Watkins is the CEO of the Great Gospel Speakers Bureau. For more information, please visit LawrenceWatkins.com.