Trading Halts Help Speedy Markets Avoid Kneejerk Mistakes

Left up to their own devices, it’s easy to see how market participants in today’s rapidly-moving trading world could have jumped to the wrong conclusion upon learning that the auditor of controversial nutrition company Herbalife (NYSE:HLF) was resigning.

But thanks to a two-hour trading halt in Herbalife’s shares, the multilevel marketing company was able to explain KPMG’s resignation was due to an insider-trading scandal at the Big Four accounting firm, not financial fraud at Herbalife.

This experience highlights the importance of halting trading in stocks when companies have crucial news they want the markets to absorb before reacting irrationally to just the headlines.

“The halt prevented misconceptions that KMPG was resigning because of the financial health of Herbalife. It was the right medicine in the right amount,” said Anthony Michael Sabino, a professor at St. John’s University.

So how do trading halts work?

Not to be confused with circuit breakers, which are triggered by dramatic price changes, trading halts are implemented by exchanges to give market participants a chance to comprehend market-moving developments.

Mechanics of a Halt

“A temporary trading halt benefits existing and potential shareholders by ensuring that material news is distributed equally among all market participants and by ensuring that all trading is based on publicly held facts,” according to Nasdaq OMX Group’s (NASDAQ:NDAQ) MarketWatch website.

Typically a company contacts the exchange where its stock is listed and requests a halt. In this case, Herbalife likely requested NYSE Euronext’s (NYSE:NYX) New York Stock Exchange prevent the company’s stock from opening on Tuesday morning.

"When you halt the stock, it lets everyone look into the story more deeply as opposed to trading on just the headlines."

- Dennis Dick of Bright Trading

From there, the exchange calls down to the floor of the Big Board and asks a senior floor official, often a governor, to put in a halt as long as there are no pending trades that are about to happen, Ben Willis, a managing director at Albert Fried & Co., told FOX Business.

The halt, known as a global halt, prevents trading around the world in that stock until news is disseminated.

“In this case, Herbalife decided to err on the side of caution,” said Willis, a former senior floor official who performed stock halts.

Just over 90 minutes after U.S. markets opened, Herbalife released a lengthy statement explaining   KPMG’s rationale for resigning and withdrawing its audit reports for the prior three fiscal years. Herbalife investors were likely breathing a sigh of relief that the resignation was caused by alleged wrongdoing by a KPMG partner, not an Herbalife executive.

Slowing HFT Algorithms 

Even though trading was halted in Herbalife’s stock, there were signs of investor concern evident in related stocks.

For example, shares of Nu Skin Enterprises (NYSE:NUS), another NYSE-listed multilevel marketing company, plunged more than 6%, likely on concerns the Herbalife halt was triggered by a broader problem in the industry.

Nu Skin “went from $46 to $43 in absolute microseconds because all the buyers saw there was news on Herbalife,” said Joe Saluzzi, co-head of trading at Themis Trading and author of Broken Markets.

Trading halts can be especially helpful in today’s world of high-speed trading, where market participants and their computers often act before thinking.

“There are so many news algorithms that just trade on headlines. When you halt the stock, it lets everyone look into the story more deeply as opposed to trading on just the headlines,” said Dennis Dick, a market structure consultant and proprietary trader at Bright Trading in Detroit.

Trading halts typically generate a surge of attention in the stock as market participants speculate about whether the looming news release will be bullish or bearish.

On the floor of the NYSE “there used to be a crowd of people around the post waiting for the stock to reopen. Now that happens more electronically,” said Dick. “It definitely drives attention to those securities. It does help to add liquidity, which can help to reduce volatility as well.”

Extended Halt Adds to the Drama

The Herbalife halt drew extra attention because the stock is among the most talked about on Wall Street, serving as a piñata for hedge-fund giants like Bill Ackman, who believes the company’s business model is really based on a pyramid scheme.

“It’s kind of a soap opera within the stock. To me it was more like a car accident: What happened? Maybe I’ll take a peak,” said Saluzzi.

The drama was enhanced by the unusually-long trading delay, which annoyed some traders who were anxious to learn the details.

Nasdaq said trading is normally resumed in a stock about 30 minutes after the dissemination of the news. The Herbalife halt was lifted 28 minutes after the statement, but just over two hours after the initial halt.

While some complained, Saluzzi said the extended delay was “not a big deal at all.” He said, “They want that news to be fully disseminated to all market participants. That’s usually a prudent thing to do.”