Monday’s 777-point fall in the Dow could have been an extended 1,500 free fall, if a team of New York Stock Exchange ’specialist’ market makers had not intervened. In a market meltdown specialists are vital, argues Martin Hutchinson in Money Morning. Faced with a rush of  “sell” orders late Monday these specialists either took the buy side or aggressively solicited for buyers of shares of several of the big financial-services companies that were part of the sell-off.

This from Martin in Money Morning:

By assuming the role of buyers — or soliciting buyers — these specialists may have helped limit losses at the closing bell, the Dow Jones news service reported.

Specialists that represent some of these financial companies said they would take “buy” orders in a late crossing session — a move that helped put a floor under some of the selling, and probably staved off an even bigger decline, Dow Jones said.

“If this was purely electronic, it could have been down 1,200 or 1,300 [points] on the Dow,” Bernie McSherry, a senior vice president with Cuttone & Co., the largest independent floor operator at the NYSE, told the news service.

When it comes to executing a dentist’s 500-share order in a liquid stock in an “ordinary” market, there’s no question that machines (computers) do the job in a perfectly adequate manner. They compare the prices available in the market, select that which is most advantageous to the dentist, and execute the trade, all in less than a second, limiting the dentist’s risk of price movements after the order has been placed. What’s more, they do this far more cheaply than a human trader, since they can — if necessary — execute thousands of orders at once.

In the 1920s, the Big Board frequently had to shut for some weekdays, so that the back-office staff could get caught up on the unprecedented volume of trading. Needless to say, that is no longer necessary: the very same machines that execute the trades handle all the details of order matching and payment.

That has been the rationale for forcing human traders out of the market, closing trading floors and using computers to “make markets.”

The NASDAQ uses computers entirely, as do several automated trading platforms such as the NYSE’s Archipelago. London gave up its trading floor as long ago as 1987, after misguided legislation forced all the trading firms into conglomerate ownership and led experienced traders to retire with their (in those days) modest winnings.

NYSE specialists have seen their market share gradually eroded, as the big institutions push for automation, and the general view a year ago was that they were due to go the way of the Dodo, and that the NYSE was being stubborn and foolishly limiting its competitiveness by continuing to allow them to operate.

That was always an implausible theory. Studies have shown that only 7% of the information in a conversation comes from the words themselves: Another 38% is gleaned from the tone of voice used, while a full 55% is derived from non-verbal clues. For maximum communication, therefore, humans need to be face-to-face — not at opposite ends of a telephone, or rattling away on a computer keyboard.

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More on this topic (What's this?)

Dow Jones 10 Year Chart - December 19, 2008 (My Trader's Journal, 12/21/08)

Top 20 one day percent decreases in Dow Jones (Dividend Growth Investor, 10/7/08)

Dow Jones Chart - September 26, 2008 (My Trader's Journal, 9/28/08)

Read more on Dow Jones Industrial Average at Wikinvest

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