Circuit Breakers in stock market in India

In times of rapid market changes, stock exchanges rely on a mechanism called a “circuit breaker” to maintain stability and protect investors.

Circuit breakers prevent extreme volatility by temporarily halting trading in the market when prices swing sharply in either direction.

Here, we’ll break down everything you need to know about circuit breakers in the stock market in India, including what they are, how they work, the concept of upper and lower circuits, and the advantages and disadvantages of using them.

What is a Circuit Breaker in the Stock Market?

A circuit breaker is a measure that temporarily halts trading when stock prices hit specific thresholds within a day.

This threshold-based system aims to prevent excessive losses or speculative gains within a single trading day. These pauses allow the market to stabilize and investors to digest any impactful news before trading resumes.

The Securities and Exchange Board of India (SEBI) oversees circuit breaker rules, which apply to the BSE (Bombay Stock Exchange) and NSE (National Stock Exchange) indices.

Also, Read | Understanding the Indian Stock Exchange

How Circuit Breakers Work in the Indian Stock Market

In India, SEBI regulates circuit breakers with three specific thresholds based on index movements of 10%, 15%, and 20% in a single trading day from the previous day’s closing level.

Here’s how each threshold affects trading:

1. 10% Movement:
   • Before 1:00 p.m.: Trading halts for 45 minutes.
   • Between 1:00 p.m. and 2:30 p.m.: Trading halts for 15 minutes.
   • After 2:30 p.m.: No halt; trading continues as normal.
2. 15% Movement:
   • Before 1:00 p.m.: Trading halts for 1 hour 45 minutes.
   • Between 1:00 p.m. and 2:00 p.m.: Trading halts for 45 minutes.
   • After 2:00 p.m.: The market closes for the rest of the day.
3. 20% Movement:
   • A 20% index movement, either up or down, triggers a full-day halt in trading, regardless of when it occurs.

These levels apply to both the NSE (National Stock Exchange) and BSE (Bombay Stock Exchange), ensuring that all markets align during these high-volatility events.

What are the Upper Circuit and Lower Circuit?

Upper Circuit and Lower Circuit are terms used to describe price limits for individual stocks. Unlike market-wide circuit breakers that focus on the entire index, upper and lower circuits apply to individual stocks to limit daily price fluctuations.

• Upper Circuit: This is the maximum limit a stock can rise in one trading day. When a stock reaches its upper circuit, trading is paused to prevent further upward movement for that day. For instance, if a stock has a 10% upper circuit and its price rises by 10% during the day, it can’t go any higher until the next trading session. This helps manage excessive speculative buying.
• Lower Circuit: Conversely, the lower circuit is the maximum drop a stock can experience in one trading day. When a stock hits its lower circuit, it prevents any further decline for the rest of the day, which can help limit panic selling. If a stock has a 5% lower circuit and hits this limit, trading in the stock will pause at that price level.

These circuit limits can vary across stocks, typically in increments like 2%, 5%, 10%, or 20%, depending on the stock’s volatility and market capitalization.

Both upper and lower circuits are in place to manage volatility, helping to avoid excessive losses or gains within a single trading day.

Advantages and Disadvantages of Stock Market Circuit Breakers

Circuit breakers come with both benefits and limitations. Let’s look at these in detail:

Advantages

1. Protects Investors from Sudden Losses: By halting trading during extreme market movements, circuit breakers give investors a chance to pause and assess the market rather than react impulsively, which can help prevent major losses.
2. Reduces Market Volatility: Circuit breakers are a stabilizing force, slowing down extreme price swings in times of crisis and helping to maintain a more orderly market.
3. Encourages Rational Decision-Making: Circuit breakers promote more thoughtful trading by giving participants time to process market information and avoid panic-driven decisions.
4. Promotes Market Integrity: By preventing irrational trading, circuit breakers uphold market integrity and protect against potential manipulation during times of high volatility.
5. Protects Small Investors: Circuit breakers give smaller, retail investors a fair chance to react to market movements rather than being impacted solely by high-frequency trading.

Disadvantages

1. Interrupts Natural Market Flow: Critics argue that circuit breakers interfere with the market’s natural price discovery process, limiting the ability of prices to reflect actual demand and supply.
2. Limits on High-Growth Potential: For stocks hitting their upper circuit repeatedly, circuit limits can restrict the potential for further price growth, especially for volatile or high-growth stocks.
3. Inconvenience for Active Traders: Circuit breakers can be frustrating for active traders looking to execute trades quickly, especially if a halt disrupts their strategies or short-term gains.
4. Potential for Increased Volatility Post-Halt: When trading resumes after a circuit breaker, it can lead to sudden movements as pent-up buying or selling orders flood in, potentially causing another sharp move.

Real-Life Examples of Circuit Breakers in India

Circuit breakers have been triggered several times in India, especially during major global or national events. Here are a couple of notable examples:

• COVID-19 Market Crash (23 March 2020): The stock market saw multiple circuit breakers during the COVID-19 outbreak, as uncertainty drove major sell-offs worldwide.
• Global Financial Crisis (2008): The economic downturn led to significant declines, triggering circuit breakers to manage volatility and prevent panic selling.

These instances show the importance of circuit breakers during times of crisis, as they provide essential breathing space for investors.

Stock-Level Circuit Filters: How They Differ from Market-Wide Circuit Breakers

In addition to market-wide circuit breakers, Indian exchanges also implement circuit filters on individual stocks.

These stock-specific circuits work similarly to upper and lower circuits, setting a limit for daily price movements on specific stocks.

Circuit filters are particularly useful in controlling volatility in stocks with smaller market capitalizations or high speculative activity, which might otherwise see extreme price swings.

Stocks with lower trading volumes and higher volatility often have stricter circuit filters, like 5% or even 2%, while more stable or larger-cap stocks may have a wider limit, like 10% or 20%.

These filters offer a more targeted approach to prevent sharp, uncontrollable movements in specific stocks.

Key Takeaways

• Circuit Breakers: Apply to the entire market index (e.g., NSE NIFTY, BSE Sensex) and are triggered by a 10%, 15%, or 20% movement.
• Upper and Lower Circuits: Limit the maximum daily price increase or decrease for individual stocks.
• Benefits and Drawbacks: Circuit breakers stabilize the market but can also interfere with the natural price discovery process.
• Historical Relevance: Circuit breakers were crucial during events like the COVID-19 pandemic and the 2008 financial crisis, offering stability when the markets were under significant stress.

Bottom line

Circuit breakers and stock-specific circuits are vital tools for maintaining stability and investor confidence in the Indian stock market.

By limiting extreme volatility, they give traders a necessary pause to think carefully, which ultimately helps foster a safer and more resilient market environment.

For both new and seasoned investors, understanding how circuit breakers work is key to navigating the markets during turbulent times.

FAQs

What is an upper circuit in stock trading?
An upper circuit is the highest limit a stock can reach in one trading day. Once it hits this level, further buying is restricted for the day.

What is a lower circuit?
The lower circuit is the maximum percentage drop allowed for a stock in a day. When this is reached, no further selling can occur at a lower price.

How do circuit breakers protect investors?
Circuit breakers prevent panic-driven trades by pausing the market when there’s a sharp swing, helping investors avoid irrational decisions based on emotion.

What triggers a circuit breaker in the Indian stock market?
Circuit breakers are triggered when major indices (BSE Sensex, NSE NIFTY) experience a 10%, 15%, or 20% movement up or down.

Are circuit breakers and circuit filters the same?
No, circuit breakers apply to the entire stock market, while circuit filters apply to individual stocks to limit their price movement.

How long does a circuit breaker last?
The length of a trading halt depends on the level of market movement and the time of day, ranging from 15 minutes to the rest of the trading day.