Since time immemorial, stock markets have been lucrative investment avenues with impeccable wealth creation potential. However, stock market investments entail significant risks as they are subject to constant market fluctuations. Thus, the magnitude of both gains and losses from stock markets is high.
On March 23, 2020, the Bombay Stock Exchange (BSE) suspended trading for 45 minutes as the SENSEX plummeted by over 10%. Specifically, the SENSEX had breached the lower circuit. Similarly, on June 21, 2021, BSE halted the trading of PNB Housing Finance stocks as its price breached the lower circuit limit of 5%.
Now, you may wonder, what are circuits? What happens when a stock hits the upper circuit at National Stock Exchange (NSE) or BSE? How to exit from lower circuit stocks?
Booming markets turn a pauper into a prince, while crashing markets do just the opposite. The October 1987 “Black Monday” crash of the US stock market caused insurmountable losses for a large number of investors. Post this incident, the circuit-breaker rule came into effect in the US stock market.
As per this regulatory mechanism, benchmark indices can move only within a prescribed range. They cannot go above or below the stipulated upper and lower limits respectively. These limits are known as circuit-breakers, circuit filters, or simply, circuits. Circuit limits of individual stocks are commonly known as stock price bands. Upper circuits are ceiling prices while lower circuits are floor prices of stocks or indices.
The Stock Market Circuit Breakers aim to restrict panic selling, curtail heavy stock accumulation, and prevent intense market volatilities. Circuit limits vary from market to market and from stock to stock.
In June 2001, the Securities and Exchange Board of India (SEBI) formulated the market-wide, index-based circuit breaker protocol to protect investors from heavy losses and prevent market crashes. As per this system, circuit filters are triggered at three levels of the index movement. Putting it differently, circuit filters are activated when the benchmark index crosses above or below the stipulated limits by 10%, 15%, or 20%.
The benchmark indices of India are NIFTY 50 and SENSEX. When one or both of these indices breach the circuit limits, a temporary, nationwide trade halt occurs. Similarly, when an individual stock price hits the circuit limits, the exchange will temporarily suspend trading of that particular stock.
A pre-open call auction session is conducted as soon as the market reopens post the trade stoppage. It is a 15-minute session for determining the equilibrium price of a stock or index based on demand and supply conditions.
In India, SEBI fixes the circuit limits for market indices. Exchanges calculate circuit limits for 10%, 15%, and 20% stages daily, using the previous day’s index closing price. The closing price is rounded off to the closest tick size. The circuit breaker rules for market indices are listed in the below table.
|Circuit-breaker trigger threshold limit||Activation time||Trade suspension duration||Pre-open call auction period|
|10%||Before 1 pm||45 minutes||15 minutes|
|Between 1 and 2.30 pm||15 minutes||15 minutes|
|After 2.30 pm||No trade stoppage||–|
|15%||Before 1 pm||105 minutes||15 minutes|
|Between 1 and 2.30 pm||45 minutes||15 minutes|
|After 2.30 pm||Till the market closes for the day||–|
|20%||Anytime during trading hours||Till the market closes for the day||–|
The same methodology can be extended to the calculation of individual stock circuits as well. Exchanges set the circuit limits for traded stocks while issuers fix the price bands for IPO stocks. As per the BSE and NSE circuit rules for stocks, stock circuits are predetermined for 2%, 5%, 10%, or 20% levels daily based on stock category. However, stocks with listed derivative contracts or part of indices with derivative products do not have circuit limits.
When a stock price reaches the upper circuit in the stock market, it means that demand for the concerned stock exceeds its supply. Specifically, buying pressures are greater than selling pressures. The converse is true when stock prices are near or below the lower circuit. After a stock hits a circuit, trading in that stock usually stops for the day.
Following are the advantages and disadvantages of stock market circuit breakers-
Circuit breakers are triggered when an index or stock price breaches prescribed limits. When sellers outweigh buyers, stock prices hit the lower circuit and vice-versa. Any particular news or global event can trigger an upper or lower circuit. There are also times when circuits are triggered without any reason. It is imperative for investors and traders to have knowledge of what circuits are and how they function.