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3 things about circuit filters
Market regulator Securities and Exchange Board of India (SEBI) recently issued a circular directing National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) to strengthen the circuit filter mechanism.
Here are three key things to know about circuit filters:
What are circuit filters:
This is basically a range provided for each index. It contains an upper limit and a lower circuit limit. The index cannot fall below the lower limit or climb above the upper limit. These limits are based on the previous day's closing price. Circuit limits are just for indices; stocks have price bands, which act in the same way. However, price bands are only available for stocks which have no derivative contracts. Even if the stock has no derivative, but is part of an index which has its own derivative contract, it will not have price bands. Also, price bands are controlled by the stock exchange, while circuit filters are set by SEBI. The market regulator has set circuit filters only for the Sensex and Nifty benchmarks.
Breaching a limit:
If the stock or index touches any of the upper or lower limits, trading is suspended. The amount of time for which trading is stopped depends on the extent of breach. The greater the change in prices, the longer the halt. The Sebi has set circuit breaker limits at 10%, 15% and 20% for the indices. If the 10% limit is hit, trading can be halted between 15-45 minutes depending on the time of breach. The 15% limit leads to a halt in trading for 45-75 minutes, while the 20% limit leads to closure of markets for the rest of the day. If the circuit limit is breached before 1 pm, then the trading is closed for a longer period of time - 45 minutes for the 10% limit and 75 minutes for the 15% level. If the breach happens after 2.30 pm, in the last leg of the trading session, then there is no halt.
Need for filters, bands:
Stocks and indices move on the basis of buy and sell trades in the market. However, in the event of news - either negative or positive - the stock or index can move by a great amount. This, however, increases volatility in the market, and may put retail investors at a disadvantage. This is because retail investors are almost always the last to react to news and sell or buy a stock. To avoid such volatility, the SEBI has instituted circuit filters and price ranges in the market. These also help limit speculative trading, which could result in big losses. The upper limit is to ensure that a stock does not rise indefinitely. Otherwise, short sellers - those who borrow stocks to sell in anticipation of a fall in prices, and later buy back at the end of the market session - do not face severe losses. Thirdly, even long-term investors benefit from such limits. Imagine, if you bought a stock at Rs 100 five years back. You are comfortable that it has touched Rs 500 today, only to let it fall back to Rs 100-levels in the course of one single day. A circuit limit avoids such drastic crashes.
On January 6, 2015, the Sensex fell 855 points, while the Nifty plunged 3% following a global selloff. This was the single biggest fall since September 3, 2013, when the 30-share index tumbled 3.5%. The slide was market-wide, not just limited to the benchmark indices. As a result, 269 stocks were locked in the lower circuit limit on the BSE.