What is Circuit Breaker?

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  • 13 Dec 2023
What is Circuit Breaker?

Key Highlights

  • Circuit breakers are temporary measures that interrupt trading to reduce panic selling on the stock exchanges.
  • Circuit breakers will be triggered for each security if the price moves upwards or downwards.
  • Based on feedback from past crises, the existing circuit breaker system has been amended several times.

A circuit breaker is a regulatory measure that suspends operations on the exchange for an extended period. A circuit breaker is a defined percentage value that determines the uncontrolled movement of a security or index in either direction. These values are compared to past closing levels of an index or security.

The establishment and monitoring of the circuit breakers mechanism shall be entrusted to the Securities and Exchange Board of India. In July 2001, marketwide circuit limits based on the index were established. In September 2013, some changes took place.

If the index or any individual security breaches the circuit limits, circuit breakers will be triggered. If the circuit limit for that index is exceeded, all stock and equity derivative transactions will be suspended. SEBI prescribes the duration of a halt, which is different for each type of circuit breaker. It's between an hour and a full trading day. After 15 minutes from the end of the pause, the markets shall reopen with a pre-open call auction.

The types of circuit breaker stock market in India are as follows.

1. The trigger limit is 10% The market will be suspended for 45 minutes and resumed with a pre-open call auction of 15 minutes if the trigger time is before 1 p.m. The market halt will be for 15 minutes and restarted with a pre-open call auction of 15 minutes if the trigger time is after 1 p.m. and before 2:30 p.m. The procedure continues if the trigger time occurs after 2:30 p.m.

2. The trigger limit is 15% If the trigger time is before 1 p.m., the market will be suspended for 1 hour and 45 minutes and resumed with a pre-open call auction of 15 minutes. The market halt will be for 45 minutes and will be renewed with a pre-open call auction of 15 minutes if the trigger time is after 1 p.m. and before 2 p.m. Trading is interrupted for the rest of the day if your trigger date falls after 2 p.m.

3. The trigger limit is 20% The volatility will be interrupted for the remainder of the trading day, irrespective of trigger timing.

Regarding positive or negative news, stock markets are driven by sentiment and tend to fluctuate. The stock price may fall out of a level that could trigger fear for investors if there is bad news. The whole sell-off of shares could cause the market to fall. A circuit breaker share market mechanism is put in place to prevent excessive price movements and avoid manipulation of prices.

The circuit breakers allow market participants to think objectively and thus avoid panic situations. The suspension of trading enables market participants to follow announcements and news, facilitating informed decision-making.

According to SEBI, three stages of index movements trigger a circuit in the stock market, i.e., 10%, 15%, and 20%. These percentage ratios are adjusted regularly following the level of security or index over time. For example, a circuit breaker may be placed on 20% of the stock for specific periods. If the exchange considers that it is appropriate, it may modify this to 10% at a later date. An exchange may even lower the ceiling to 5% and 2% as it sees fit in the case of illiquid stock securities or as a price management mechanism. On the other hand, securities that offer derivative products are subject to dynamic circuit filters.

Circuit levels are breached, and trading is instantly stopped. The increase or fall and the stopping time determine how long the suspension lasts. Following the conclusion of the halt period, trading resumes, and business as usual is carried out.

The benefits and drawbacks of circuit breakers are as follows.

Advantages Disadvantages
A circuit breaker provides an essential benefit to investors, regulators, and stock exchanges by suspending the trading of a single security or index so that investment decisions can be made more quickly.1. As investors are prevented from selling shares, the circuit breaker can cause panic. Before breaching the circuit limit and suspending trading, nervous investors may sell their shares on a sliding market.
Second, circuit breakers on stock exchanges help protect investors from high losses because they limit panic selling that could take place in the market.2. Secondly, circuit breakers are designed to prevent real-time price fluctuations and thus cause the market to be artificially volatile. It reduces liquidity and simultaneously increases the number of orders at a limited level. Market experts believe markets would be more stable if their movement had no restrictions.
In addition, the implementation of an upper circuit breaker prevents stock accumulation.3. As circuit breakers temporarily reduce market volatility, stock markets cannot be prevented from falling.

Conclusion

Circuit breakers are helpful to reduce market volatility and ensure a smooth and safe trading environment. It allows traders and investors sufficient time to recover from their losses and take corrective action while avoiding a complete market crash.

FAQs on Circuit Breaker

In June 2001, the Securities and Exchange Board of India (SEBI) introduced index-based market-wide circuit breakers. Due to panic sales of stocks, circuit breakers are triggered so that the markets don't crash.

A circuit breaker functions like an automatic switch with a base current value and switches off the circuits where it has been installed every time this value is exceeded.

A circuit breaker is a type of regulatory action that stops an exchange's trade temporarily. Circuit breakers are defined percentages of movements within a security or index in any direction, ensuring no uncontrolled movement.

A circuit breaker will be triggered if India's index rises by 10%, 15%, or 20%. Trading will continue if the index moves by 10% after 2:30 p.m. because the end of the trading day is usually more volatile. However, trading will be suspended for fifteen minutes when movements occur between 1 and 2:30 p.m.

There are no set daily circuit restrictions for stocks with Futures & Options (F&O) contracts. But there's a fixed price band of 10 %.

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