A reasonable safeguard

The Financial Services Commission has announced it will double the daily stock price limit to plus or minus 30 percent starting Jan. 1. The commission hopes the move will increase trade volume and revitalize the bourse. It already has shaken things up in the financial industry. While many investors and securities companies have long demanded relaxing the limit or eliminating it entirely, others say it is appropriate to ensure the stability and security of equities.

Let’s study two facts before we weigh the pros and cons of stock price limits. Before the Asian financial crisis in 1997, stock prices were allowed to move in ranges of 2.5 percent and 3.5 percent per day. Those bands selected as cheaper stocks could can move in a bigger range than higher-priced ones. The range was expanded to the current 15 percent to advance the stock market in the wake of the financial crisis.

The expansion was to provide investors more accurate information about the potential of the underlying stock value by allowing more price movement. At the time, investors bought when stock prices hit the upper limit and sold when they reached the bottom. The herd assumed the stock would move in the same direction the next day and it was important to act quickly.

On Oct. 19, 1987, the U.S. stock market suffered an intraday loss of 22 percent. U.S. share prices fared well last year, and their full-year gain was 29 percent, suggesting what chaos was caused on Wall Street by that Black Monday in October. Once the free fall calmed down, U.S. securities pundits and authorities embarked on an in-depth study. They decided the free fall was possible because there had not been a safeguard to halt panic trading. Since then, U.S. authorities institutionalized a trading halt for a cooling-off period when prices rise or fall at a predetermined level.

Too much regulation was the problem in the first case and too little in the second. A reasonable safeguard is therefore important to ensure sustainability and security in a stock trading bourse.

The price limit is a protection against the worst scenarios. Humans are susceptible to greed and can be swept up in fear and intoxicated by the moment. The market, therefore, cannot be left entirely to move on its own instincts. It needs constraint in case it loses control.

Domestic small and midsize capitalization stocks are highly volatile. In the first half alone, there were many quotes that saw prices more than double in just a couple of months. Let’s presume there had not been any limitations. A stock on an upward spiral could jump on new positive news. That could be dangerous if any manipulative forces were behind it. In an extreme case, a stock could lose all its fundamentals in just a day. Regulations and systems are enforced in a bourse so investors can safely trade securities. The upper and lower bound can be the best security for investors.

Those who want the limits to be scrapped argue for trading convenience. They complain that artificial constraints prevent investors from freely selling and buying securities.

But their argument does not have logical grounds. Only a few stocks hit the upper or lower limit on any given day. Most hardly ever move beyond the predefined range. Gains and losses for most large-cap shares are small. The best known blue-chip company, Samsung Electronics, hits the limit once every decade or so. Most shares are comfortable within the set range.

Regulations and systems are necessary evils. Fewer are better. But still they are needed to prevent the worst from happening. Regulation, therefore, should be expanded. The 15 percent range is a reasonable level for tradability and emergencies. There is no need to meddle with a system that worked well.

Translation by the Korea JoongAng Daily staff.

*The author is the director of research division at I’M Investment & Securities.

by Lee Jong-woo