Wednesday, 6 January 2016

How Do Circuit Breakers Work in The Stock Markets?

In the simplest language possible – a circuit breaker or circuit filter signifies the maximum that a stock (or the market as a whole) could rise or fall before trading in that specific stock (or in the market as a whole) is halted for a certain duration of time.
Once a circuit breaker is applied, no orders can be placed until the trading resumes. However, existing orders with your broker can be modified/ cancelled.
2 points are worth keeping in mind:

[I] Why the need for circuit breakers?

Oftentimes, stock prices fall (or rise) based on news flows; imagine a bad news which leads a panic sell off which results in a domino effect. As more and more investors start dumping their stock, valuations and price often lose their inherent correlation.
To avoid an unwarranted selloff and in order to give investors a chance to reconsider their decision, trading in the stock is halted for a certain period of time. Similarly, when there is an unwarranted buying, the filter is applied so that investors are not swayed by artificial exuberance, if such were to be the case.

[II] At what level are circuit breakers applied?

Two separate things are at play with regard to the level at which circuit breakers are applied.
  • Circuit Limits:
On exchange wide basis or Index circuits (Sensex and Nifty), there are three levels at which the circuit breaker kicks in – 10% | 15% | 20%. Once the Sensex or the Nifty moves that much in either direction, trading is halted in all equity and equity derivative markets across the country . yesterday trading 💹 was halted in Chinese markets due to triggering of circuits
On stock basis, - circuits on individual stocks circuit filters are applied at 2% | 5% | 10% | 20% levels. The exchange has pre-defined list of scripts for each of these levels. Circuit breakers are not applied to scripts on which derivative (F&O) products are available and which are part of indices on which derivative products are available.
  • Timing
If the 10% movement happens before 1 PM (in either direction), there is a 1 hour halt in trading. If such movement takes place before after 1 PM but before 2.30 PM, there is a halt of 30 minutes. If the movement happens after 2.30 pm, there is no halt. 

Once the market reopens for trading, the circuit breaker limits are revised such that a further 10% movement will not halt trading but in case the movement exceeds 15% (in either direction), there is a halt in trading. In case, the further 15% movement takes place before 1 PM – the halt is 2 hours. if the movement is after 1 PM but before 2 PM – the halt is 1 hour. There is no halt in case the movement happens after 2 PM.

Once the market reopens for trading – if it hits 20%, trading stops for the rest of the day.

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