Generally, stock prices move up and down based on their fundamentals, quarterly results, yearly results, government policies, trends in the industry or some corporate actions. Such price movements in the stocks are quite reasonable and logical. But in some cases, the stock price increases/decreases exponentially by some irrational exuberance or fear caused by a certain news about the stock. Sometimes, the movement of stock prices can beat all logic and move tremendously in any direction.
In order to maintain the sanity of the stock market, to curb the drastic moves of a stock in upper/lower direction, and to stop the actions that could sometimes lead to a panic selling or buying, driving the prices haywire, circuit limits are applied.
A circuit limit or a circuit breaker is defined as the limit either upper or lower, a stock could rise or fall, before the trading of the stock is halted depending upon the time at which the stock hits the circuit.
The Securities and Exchange Board (SEBI) has defined various circuit levels namely 2%, 5%,10%, and 20%. These values are applied to the price of the stock at which it closed on the previous day.
For e.g If ABC stock has closed at Rs 100 yesterday and if it has a 10% circuit limit, then today it will have circuit limits of Rs 90 and Rs 110 as lower and upper respectively. That means if the stock reaches Rs 90 or Rs 110, then the trading for the stock will be halted.
If the price reaches 90, there will be no bids in the order book. Similarly, if the price reaches 110, there will be no asks in the order book.
These circuit limits such as 2%, 5%, 10% and 20% are defined by the exchange depending on various factors. There's no restriction on the number of times the Exchange can revise the circuit limit. Circuits are revised on a need basis based on the Last Traded Price of the stock. Whenever the stock is plunging in its value drastically then the exchange can decrease the circuit limits for that particular stock. If a stock hits the lower circuit limit of 10% for continuous 2 days, in order to stop the sudden downfall of the stock, the exchange may decrease the circuit limit for the stock to 5%. The reason being, there will be a huge loss for the investors who hold the shares if the circuit limit is not decreased. And one single news cannot be used to doubt the strong fundamentals of a particular stock.