A stock market is a volatile place where stocks move abruptly and sometimes within a few minutes, surge or goes down making some traders lose their money, at the same time few traders make a huge amount of money due to such unexpected moves.
The volatility in the market, individual stocks, sudden negative or positive news or various other reasons trigger such stocks at very high levels. To control such stock price changes stock exchanges have created the circuit breaker that stops trading.
What are Circuit Breakers in Stock Market?
A circuit breaker is a mechanism created by the stock exchange that has been set up for the stock market to safeguard investors from such unexpected highly volatile changes. Stocks or indices are put into the circuit breaker category with certain upper and lower circuit limits that get triggered when the price of levels reaches that level.
Circuit breaker triggers when stock price touch either upper or lower levels set by the exchange. And when a circuit breaker triggers, it stops trading in that stock for a specific time and during that period nobody can trade in that stock. There are two types of circuit breakers in India – upper circuit and lower circuit, let’s talk about these circuit breakers.
What is Upper Circuit in Share Market?
When a stock price and index move at a higher side but stops at a point and cannot rise in a day is known as the upper circuit. The upper circuit is the maximum possible price that the stock can trade on that particular day.
The upper circuit does not remain for the entire day, there are specific percentages defined, when the stock hits these limits, according to that trading is halted for a specific duration. Fe stock's upper circuit is set merely at 2% above than previous day's close, while most of the other stocks have upper circuits between the 5%, 10%, or 20% above their precious close.
What is Lower Circuit in Share Market?
Just like the upper side, at the lower end if a stock falls at certain levels and trading is paused then it is due lower circuit. Sometimes traders especially short sellers try to sell the stock at low levels which can make a huge loss for investors having long positions.
To protect against such unusual selling, the stock exchange has imposed a limit at the lower circuit. Here again just like, the upper circuit, for a few stocks the limit is 2% lower than the previous closing price, while most of the other stock is put under the range of 5%, 10%, 15% or 20% lower than the previous day’s closing price beyond that stock will not go down.
For indices the circuit breaker limit is between 10%, 15% and 20%. And when the index rises or goes down beyond all these limits, the trading is halted not only in the equity market but also in the derivatives market.
What Happens When Indices Hit Upper or Lower Circuit?
When any index let's say NSE's Nifty or BSE's Sensex rises or falls 10% before 1 PM, then trading is halted only for 45 minutes. And if this 10% rise happens between 1 PM to 2:30 PM, then trading is paused merely for 15 minutes. While if the index rises 10% after 2:30 PM, trading is not paused and it is considered a higher volatility index (VIX).
Similarly, if the index price rose or fell 15% before 1 PM, then trading is halted for 1 hour 45 minutes and if this happens after 2:30 PM then, trading is halted for 45 minutes. However, when after 2:30 PM market index moved 15% on either side the trading is suspended for the entire day, till the close of the market trading hours.
Finally, when the market index hits the third circuit breaker limit which is 20%, then trading is stopped for the entire day, which means trading does not happen again that day.
What Happens When Stock Hits Upper Circuit?
Similarly, in stocks when they hit the upper circuit, trading is either paused for a few hours or suspended for the rest of the day. Depending on the category and volatility of the stock it is put under the different circuit breaker limits that is – 5%, 10%, 15% or 20% from the previous day's closing price. Exchange decides the stock's circuit breaker limit.
What Happens When Stock Hits Lower Circuit?
On the lower side, when stocks start falling and hit the lower circuit, they either paused for a few minutes, or hours or trading is suspended for the entire day.
The stock prices are daily determined by the demand and supply in the market, usually when buyers are dominating or more than sellers, the price of such stocks moves at a faster speed, and there is much chance of hitting the upper circuit.
While on the other hand, when sellers are leading the market or ruling on any stock on that particular day, then there is a chance of hitting the lower circuit. Sometimes, market manipulators or speculators manipulate the price of the stock and push that into the circuit breaker range intentionally with the motive to stop trading for that day.
How to Know the Upper and Lower Circuit of a Stock?
The limit or percentage range of upper and lower circuits of an individual stock is determined by stock exchanges, as per the guidelines of the capital market regulatory authority, in India of course securities and exchange board of India (SEBI).
To know the upper or lower circuit of any stock you have to visit the website of that stock exchange and check the list of stocks put into the circuit breaker limit with different percentage changes. The circuit limit does not remain the same every day, depending on the volatility of the stock, trading patterns and market condition the circuit limit changes.
SEBI Rules for Upper & Lower Circuit for Stocks
The main motive of SEBI’s imposing the circuit breaker is regulating the excessive price fluctuation that happens in a single day. Though, the circuit limit is not applied forthe stocks that are listed in the derivative segment or part of underlying derivatives.
The circuit breakers function as market controls in case of an overjoyed buying or selling day. And last but not least, circuit limits also help restrict stock price manipulation that is usually done by the speculative traders in the market.
The Securities and Exchange Board of India (SEBI) has specified certain rules and regulations regarding circuit breakers in the stock market. Though SEBI has imposed these rules and instructions it is implemented by the stock exchanges.
- As per the SEBI, the stocks are put under three stages of the circuit breaker, 5%, 10%, 15% and 20 % above or below than previous day’s close price.
- According to SEBI guidelines, the trading in stocks is stopped, if the stock price rises or falls to 10%, 15% or 20% of its last closing price.
- SEBI said exchanges like NSE & BSE both can decide the change in circuit filter percentage by displaying daily notices.
- In case there is any unusual trading or suspicious activity in the stock, the exchange can apply a filter to the circuit limit as per the wish.
- Apart from daily circulars for circuits for different stocks, the exchange can have weekly, monthly, quarterly or yearly circuit rates that are restrictions applied on the stock's price movement within the week, month, or annual respectively.
Pros and Cons of Upper & Lower Circuits
Though, the circuit breakers have been imposed by the SEBI and exchange to control the unusual price fluctuations in stocks. It has benefits and some drawbacks, let's find out how it is good for traders and what are the side effects.
Benefits of Circuit Breaker in the Stock Market:
- When trading in a stock paused due to touching the circuit limit, then it gives the time to traders think about whether to invest or not.
- The halt time also gives spare time to think, analyse the stock more technically, and fundamentally or check the news, and corporate announcements and decide how such things affect the price of the stock and take the next action.
- If the market is running smoothly and suddenly breaks the circuit then trading is paused, as there might be a panic situation in the market and traders or investors will also start buying or selling hastily creating more panic in the market.
Drawbacks of Circuit Breaker in the Stock Market:
- The real-time price movement of the stock will be unknown when trading stopped due to circuit breakers.
- Traders will be not able to exit from their intraday position if trading is stopped due to upper or lower circuit limits.
- Stocks regularly hitting the upper or lower circuits are not suitable for technical analysis, as the chart patterns are not reliable.
- If main indices hit the circuit breaker and trading stopped for the entire market, then the position in other stocks also stuck for the day.
The main motive of circuit breakers is to safeguard investors from speculative and manipulative based trading. Usually, when buyers overweight the sellers, then stock price or indices hits the upper limit and vice-versa.
Sudden stock movement can be triggered due to any reason like the economy, industry or company-related important news, corporate actions or a scam in the company. And sometimes, institutional investors start buying the stocks in bulk, and the price hits the circuit limit. Similarly, there might be many reasons, the stock can hit the circuit limits.
A swing trading in stocks can cost an investor losing his money if such circuit breakers are not imposed by the exchanges. Hence, every investor or trader should be fully aware of the circuit limits before selling or buying the stocks for intraday trading or investing.
Here, you should also take advice from the experts, who have updated knowledge of stocks that come into different circuit limit ranges. They know where stock can hit the circuit, so they recommend to buy or stock with a stop loss to avoid such circuits helping investors and traders not choose such stocks that can touch the circuit helping them to not stick into the circuit hitting stocks and choose the right stocks for trading.
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