Circuit Breakers in Stock Market Meaning & Levels

The stock market can sometimes rise or fall so rapidly that investors panic. In such times, a circuit breaker system is in place to stabilize the market. It temporarily halts trading to reduce panic and give investors time to assess the situation. In India, SEBI implemented this system to stabilize the market. In this blog, we'll explore what a circuit breaker is, why it's used, and how it protects your investments.

What is a Circuit Breaker in the Stock Market?

A "circuit breaker" is a regulatory mechanism that automatically halts trading for a period of time when a significant stock market index (such as the Nifty 50 or the BSE Sensex) or the price of a particular stock moves sharply up or down. This action is implemented to reduce excessive market volatility, panic, or prevent ill-considered decisions. In India, it is primarily directed by the Securities and Exchange Board of India (SEBI) and its primary objective is to protect investor interests and maintain market order.

Why Were They Introduced? 

This system was introduced because strong and sudden market crashes demonstrated that, without any restraint, the market could fall or rebound very quickly, causing significant losses to investors. For example, the "Black Monday" crash of the US market in 1987 brought the concept of circuit breakers to the forefront. In India, this rule was implemented from July 2001 and was later amended in 2013. Since then, the methods and levels have changed from time to time to keep it in line with current trends and investor behavior.

How Circuit Breakers Work in India?

Circuit Breaker Framework of NSE and BSE : 

In India, both the NSE and BSE exchanges operate a uniform circuit breaker system established by SEBI. Whenever the Nifty 50 or Sensex moves up or down a specified percentage (10%, 15%, 20%) from the previous day's close, trading across the entire market is automatically halted. This is intended to protect the market from sudden sharp falls or surges and provide a stable environment for investors. Both exchanges halt trading at the same time to avoid imbalances in any one market.

Circuit Breaker Levels (10%, 15%, 20%) Timing and Rules : 

According to SEBI, index circuit breakers are imposed at three levels. The duration of the trading halt at each level depends on the time of day when the decline or rise occurred.

Stock-Level Circuit Breakers (Price Bands)

What are price bands?

Unlike index circuits, price bands are imposed on individual stocks. This means that the stock's price cannot move above or below a certain limit during a trading day.

In India, SEBI sets these bands at 2%, 5%, 10%, and 20%.

Example: If a stock has a 5% price band and its close is ?100, it cannot trade beyond ?95–105 during the day.

Price bands are applied daily and are intended to prevent excessive fluctuations in a stock's price.

How do price bands protect investors?

• Preventing manipulation: Preventing large players from suddenly driving prices up or down in small or less-liquid stocks.

• Pump-and-dump protection: Preventing fake news from causing stocks to surge 15–20% overnight, trapping people.

• Preventing panic falls: Reduces the likelihood of a stock falling 30–40% in a single day due to a rumor or news.

• Time for investors to reflect: Price halts allow investors to make informed decisions rather than relying on emotions.

What Triggers a Circuit Breaker? Real Reasons Behind Market Halts

Sudden Negative News : 

When significant negative news emerges on a particular day, such as an international conflict, a sharp drop in global markets, the disclosure of fraud at a major company, or an unexpected government policy change, investor confidence is immediately affected. Such shocks trigger a sharp sell-off in the market, sending indexes plummeting. This situation is the primary reason for circuit breakers to trigger, preventing the market from falling uncontrollably and giving investors time to assess the situation.

Rapid Changes in Investor Sentiment: 

The stock market isn't driven solely by data; investors' psychological reactions also play a significant role. Sometimes, a rumor, a viral social media scare, or a negative economic signal can cause investors to panic and sell all at once. Such a collective reaction can trigger a sudden, sharp decline in the market. At such moments, circuit breakers slow the market's momentum and prevent overly emotional or hasty decisions.

Increasing Volatility Due to Algo Trading : 

A large portion of trading in today's market is conducted through algorithms and high-frequency systems. These systems generate large orders within seconds, and if the market is already in a volatile situation, algo-triggered trades can exacerbate sudden fluctuations. While regulations on HFT in India are relatively strict, global events or rapid inflows and outflows can increase volatility. In such circumstances, circuit breakers control abnormal movements by stabilizing the market.

Observable Behavior from Actual Events :

Whenever the market suddenly falls sharply, investor reactions change within minutes. In the initial minutes, panic is visible, followed by gathering information, and soon the market mood settles somewhat. It has been observed many times in the past that after a circuit breaker is implemented, investors have time to understand the market and calm down. This is why long-term investors view these moments as opportunities rather than fears, as the market pause significantly reduces the risk of uncontrolled losses.

Strengths of Circuit Breakers

Power to Prevent Markets from Uncontrolled Declines : 

When the market begins to fall sharply, circuit breakers immediately halt trading to control the pace of the decline. This creates an environment where prices do not fall uncontrollably, preventing investors from suffering significant losses.

Time for Investors to Understand the Situation and Improve Decisions:

When trading is halted, investors are cut off from the noise for a few minutes. During this time, they can evaluate the news, analyze the market direction, and avoid hasty decisions. This time often improves their strategy in the long run.

Helps Build Confidence in the Market : 

Circuit breakers reassure investors that the market does not move unchecked. This confidence is especially important for retail investors, as they feel secure that the exchanges and SEBI are protecting them from major fluctuations.

Preventing the Spread of Systemic Risk : 

Big news can sometimes spread panic throughout the financial system. Circuit breakers prevent this fear from spreading immediately and slow down the domino effect, limiting risk in banking, derivatives, and other sectors.

Risks & Criticisms of Circuit Breakers

Trading Halts Increase Panic : 

Sometimes, investors become increasingly fearful upon hearing news of a trading halt. They believe the market situation is worse than anticipated, leading to panic reactions upon reopening.

A Sudden Price Rise or Fall : 

When the market reopens, prices can fluctuate rapidly within seconds. This rapid volatility is inconvenient for those expecting stable trading, and many orders may be executed at the wrong levels.

Impact on Intraday and Algo-Based Strategies : 

Trading halts pose a significant obstacle for daily traders and algorithmic systems. Their strategies rely on continuous movement, and the halt disrupts their timing, potentially reducing potential profits.

Delays Natural Market Adjustments : 

If an event is bound to impact prices, a circuit breaker delays that process. The sudden, sharp fluctuations after reopening make the market feel volatile and less understandable for new investors.

What Should Investors Do During a Circuit Breaker?

Stay calm and avoid panic trading : 

A circuit breaker does not mean the market is ending; rather, it is a temporary pause. It is best to avoid panic selling or buying at such times. Emotional decisions often lead to losses, so it's better to assess the situation carefully rather than reacting immediately after the market halts.

Focus on the quality of your portfolio, not the stock price : 

During a downturn, prices may not reflect real value for a few minutes. Therefore, investors should avoid making decisions based solely on price. It's better to consider the strengths, business models, and future stability of the companies in your portfolio. Strong companies often recover first after a temporary decline.

Don't place market orders immediately after the market reopens : 

Prices fluctuate rapidly during reopening. Placing a market order during this time could result in the order being executed at the wrong price, leading to unwanted losses. In such situations, using a limit order is safer, as it allows you to trade at a predetermined price and reduces uncertainty.

Understand the Reason for the Fall, Not Just the Fall : 

Every major fall has a reason. Sometimes global cues are bad, sometimes economic announcements shake the market. When a circuit breaker is triggered, the most important thing is to understand the underlying cause. If the fall is due to external factors, it may be temporary. However, if the fall is due to fundamental concerns about a sector or company, investors should make decisions more cautiously.

Balance Opportunity and Risk : 

Circuit breakers often make good stocks available at very attractive prices, creating an opportunity for value-based investors. However, it is important that investors avoid investing in stocks that appear cheap. Averaging without thinking can increase losses. It is wise to focus only on stocks with strong long-term potential.

Conclusion

Circuit breakers act as a protective shield for the market, controlling sudden volatility and providing investors with a balanced environment. They not only reduce panic but also provide the necessary time for decision-making. While disruptions can sometimes raise concerns, this system plays a vital role in keeping the market stable and reliable. It is wise for investors to remain calm during such times, understand the reasons, and prioritize the long-term vision.

FAQs

Q1. What is a circuit breaker in the stock market?

A circuit breaker is a system that halts trading when the market experiences sharp fluctuations.

Q2. Why does a market hit a circuit breaker?

When an index moves above or below a set percentage, a circuit is triggered to calm the market.

Q3. How long does a circuit halt last?

It can last from a few minutes to a full day, depending on the level and duration of the movement.

Q4. Do individual stocks also have circuit limits?

Yes, each stock has daily price bands that determine its upper and lower limits.

Q5. What happens when the market reopens after a halt?

Prices may fluctuate rapidly for a short while upon reopening, so caution is necessary.