Stock markets are volatile is a known fact. In minutes the price of a stock can shoot up or go down by a tremendous margin. This volatility has often led the investors to suffer major losses and sometimes even drained their entire life savings. The huge volatility in the stock prices often triggers the stock exchanges and can lead to a stop in trading for a few minutes when a stock price reaches the upper circuit or the lower circuit.
Given below are the meaning of the upper and lower circuit in the market and the related details.
What are circuit breakers in stock market?
A circuit breaker is a mechanism set up in the stock markets to safeguard investors from extreme price volatility. Every stock, as well as indices, has a defined upper circuit and a lower circuit that gets triggered when they reach such a price level. This is known as a price band and when the stocks reach the upper or lower level set, the circuit breaker gets triggered. This circuit breaker closes the trading for a set time period and allows the investors to react to the volatility without any panic. There are two types of circuit breakers in India and the details of the same are given below.
a. Circuit breaker for stocks- Upper and lower circuits
Circuit breakers for stocks are the upper and lower limit set for individual stocks. These limits are set every day based on the last traded price of the stock and are defined as a percentage. These limits are triggered when the stock reaches the upper limit or the lower limit of the price band. Such a price band can be anywhere between 2% to 20% of the stock price and is determined by the stock market.
b. Circuit breaker for indices
Circuit breakers are the price band or the upper and the lower limit at which indices can be traded. It is triggered when the index falls or rises beyond the set limits like 10%, 15%, or 20% of the previous day’s closing price. When the index reaches such levels, the trading is stopped across all the securities like stocks as well as derivatives. It is a fail-safe mechanism to protect investors from sudden volatility of the market.
Circuit limits in Indian Stock Markets
Circuit breakers were introduced in the Indian stock markets in the year 2001 by SEBI as a measure to safeguard the investor’s interest and protect them from the extreme volatility of the markets. The circuit limits for the stocks are determined on a daily basis depending on the market conditions and the level at which a particular stock is traded. On the other hand, for indices, there have been predefined levels by SEBI which trigger a circuit breaker and the trade is suspended for a set period of time or for the remaining part of the day as the case may be. The re-opening of the markets after a circuit level is breached is followed by a 15-minute pre-open auction session post which the normal trading can continue provided another circuit breaker is not triggered. The circuit breaker levels for indices and their impact are tabled below.
|Circuit Trigger Level||Trigger time||The duration for which market trading is halted||Pre-open auction session|
|10%||Before 1 pm||45 minutes||15 minutes|
|10%||At or After 1:00 pm to 2:30 pm||15 minutes||15 minutes|
|10%||At or After 2:30 pm||No halt||Not applicable|
|15%||Before 1 pm||1 hour and 45 minutes||15 minutes|
|15%||At or After 1:00 pm to 2:30 pm||45 minutes||15 minutes|
|15%||At or After 2:30 pm||Remainder of the day||Not applicable|
|20%||Any time during the day||Remainder of the day||Not applicable|
Need and implication of circuit breakers
The prices of the stocks are sensitive to any positive or negative news related to a particular industry, company, or any political change among many other factors. Such news drives the market sentiment and influences the price volatility of the stocks. An extreme price fluctuation can result in a panic among investors and often lead to rash decisions as they are almost always the last party to react to a particular event or news.
To avoid such scenarios, circuit breakers were introduced to ensure the protection of investors’ interests and safeguard them from any price manipulation by stock operators. A circuit breaker allows the investors to react to the market fluctuations in a calculated manner rather than make a hurried or a panic-driven decision.
Pros and cons of circuit breaker
The introduction of circuit breakers was to provide the investors with a breather to react to market fluctuations in a better fashion and protect their interests. However, there are several pros and cons of a circuit breaker. Some of such pros and cons are mentioned below.
Some of the pros of the circuit breakers are mentioned below.
- The biggest advantage of circuit breakers is the halt in the trading activities for a fixed duration. This allows the investors to get all the relevant facts regarding the triggering event and make their investment decisions accordingly.
- It protects the investors from speculative trading which can potentially lead to huge losses.
Some of the disadvantages of circuit breakers are mentioned below.
- It restricts real-time price movement during the market halt.
- Investors with early access to the market news and market sentiments can take better advantage of the same as compared to investors who may not be aware of such a circuit break.
Some of the crucial facts related to upper and lower circuit are:
- The circuit filters for stocks are established by considering the previous day’s closing price.
- Investors can obtain information about circuit filters from the stock exchange’s official website.
- Stocks are typically subject to a 20% circuit filter, as a protective measure.
- If a stock reaches its upper circuit, the demand for it is so high that there are only buyers and no sellers, and conversely, if it hits the lower circuit, there are only sellers and no buyers.
- In the event of a circuit limit being hit, intraday trades will automatically convert to delivery trades, and this is something investors must be aware of.
Breaching the upper limit and the lower limit of stocks and indices is a common phenomenon in the stock markets. The reaction to such a breach, however, can be extreme and often lead to huge investor losses. Circuit breakers ensure that the investors get time to react to market fluctuations more effectively and make sound investment decisions.
The circuit limits for stocks and indices are decided and implemented by SEBI
When the market halts due to a circuit break, it calls for a pre-open auction session. The price of the stock is decided based on the demand supply functions of the market. The opening stock prices are discovered based on the bidding which is known as price discovery.
The minimum level notified by SEBI for a circuit breaker in indices is a 10% drop or rise in the indices.
The upper limit and the lower limit of stocks change on a daily basis based on the previous day’s closing price levels.
In the case when a stock breaches the upper limit set for such stock, there will be only buyers for such stock and not sellers. On the other hand, when a stock reaches the lower limit set, there will be only sellers of such stock in the market and no buyers.