What is a Circuit breaker in the Stock Market?
Circuit breaker explained
When market participants are carried away by an excess of pessimism or optimism, regulators have a way of reining them in
Most people consider Friday the 13th an unlucky day, well, for stock market traders and investors, Friday the 13th 2020 started poorly. The Nifty (NSE) plunged 10 per cent, triggering a circuit breaker that halted trading. Shortly after that the BSE also halted trading when the Sensex dove 9.4%. The market recovered subsequently and even ended up in the green recovering the day’s losses.
The fall in the indices was the result of fears emerging from the spread of Coronavirus. The disease is now declared a pandemic by the World Health Organisation (WHO). This contagion has affected stock markets across the world and not just India. The events of 13th March 2020 are one of the many examples.
What is a Circuit Breaker?
So what is a circuit breaker in the stock market, and how does it work? A circuit breaker occurs when stock prices go into a steep decline or sharp rise during an intraday trading session. All trading activity is stopped for a while to let markets settle down. It also helps curb panic and irrational transactions which could have detrimental effects in short to medium terms.
Circuit breakers are set at different levels in different stock markets. In India, the circuit breakers get triggered whenever the BSE Sensex or NSE Nifty drops by 10%, 15% and 20%, and trading gets halted for a specific period.
|When are circuit breakers triggered?|
|Trigger Limit||Trigger Time||Duration of Halting Trades|
|10%||Before 1 pm||45 Minutes|
|At or after 1 pm up to 2.30 pm||15 Minutes|
|At or after 2.30 pm||No halt|
|15%||Before 1 pm||1 hour 45 minutes|
|At or after 1 pm before 2 pm||45 Minutes|
|On or after 2:00 pm||The remainder of the day|
|20%||Any time during market hours||The remainder of the day|
As we can see, the circuit breaker stock market will depend on the extent of the fall in price and the time.
History of Circuit Breakers
Circuit breakers were introduced by the Securities & Exchange Commission (SEC) in the USA following the stock market crash on 19th October 1987, when the Dow Jones Industrial Average plummeted by almost 23 per cent in a single day. This day remembered as `Black Monday’ in the US even today.
In India, this is not the first time circuit breakers have been used to prevent stock prices from crashing or skyrocketing. On 17th May 2004, trading was closed after the BSE Sensex plunged 11 per cent in the first few minutes of trading following the news about the good performance of the Congress in the Lok Sabha Elections. Paradoxically, on 18th May 2009, markets hit two upper circuit limits after the victory of the UPA (United Progressive Alliance) government in the Lok Sabha elections.
Circuit breakers apply to individual shares as well. However, shares that are traded in the derivatives segment of the stock market do not have any circuit breakers.
So a circuit breaker in the stock market is one of the ways market regulators have to prevent participants from being carried away either by excessive optimism or pessimism.