What is a Circuit Breaker?

Circuit Breaker in Indian Stock Market

Introduction

A circuit breaker in a stock market is a system by which stock exchanges prevent excessive fluctuation of a stock or index. Lets discuss the details of circuit breakers in Indian stock market in this article.

What is a Circuit Breaker in Stock Market?

• A circuit breaker is a system by which stock exchanges prevent excessive fluctuation of a stock or index. In other words, it is a measure to curb excess volatility in the share price of an equity.
• Since, stock markets are extremely volatile, circuit breaker helps in keeping a check on market manipulation by big investors or brokerage houses.
• Circuit breaker system is applied at 3 stages of the index movement, i.e. at 10%, 15% and 20%.
• These circuit breakers when triggered bring about a coordinated trading halt in all equity and equity derivative markets nationwide.
• The market re-opens, after a temporary halt, with a pre-open call auction session. The extent of duration of the market halt and pre-open session is as given below:

Exchange shall compute the Index circuit breaker limits for 10%, 15% and 20% levels on a daily basis based on the previous day’s closing level of the index rounded off to the nearest tick size.

Types of Circuit Breaker

• Circuit breaker are of two types:
  1. Upper Circuit
  2. Lower Circuit
• Upper Circuit :
  • These are upper limits defined by stock exchanges on share price of stocks. A stock is not allowed to appreciate more than 20% in a single day with respect to its previous closing price.
  • For example: Suppose, TCS closed at Rs.100 on the previous day. Then upper circuit level becomes Rs.120 for TCS. So, on the next day, the maximum value at which the share can trade will be Rs.120
• Lower Circuit:
  • Similar to upper circuit, lower circuit level determines the lowest price at which a stock could trade for that day.
  • For example: If TCS had closed at Rs.100 on the previous day, its lower circuit level would become Rs.80 and would not be allowed to trade at a price lower than 80 for that particular day.

Circuit Breaker System in Indian Stock Market

• Circuit breakers are applied very often on various stocks across the market. Usually, small cap stocks which manage to come under news, are halted by circuit breakers.
• However, there have been very few instances of markets coming to halt on triggering of circuit breakers ever since the system was introduced in June 2001.
• The first time the trading was stopped because of circuit breakers was on May 17, 2004 when trading had to be halted twice in the day.
• Subsequently, trading was halted because of circuit breakers on May 22, 2006, October 17, 2007 and January 22, 2008.
• On all these occasions, the circuit breakers were applied on the downward movement of the indices.
• However, on May 18, 2009, the halt occurred due to the bullish stance of the market which resulted in SENSEX moving to 14,300 points from 12,100 points.

Drawbacks of Circuit Breakers

1. The first downside of circuit breakers is that they prevent true price discovery in a stock both on its way up or down, at least for the limited time period they are imposed.
2. Secondly, they allow early investors (usually well-informed institutions or Algo traders) to gain advantage and make a move before circuit breakers are eventually invoked.
   • It thereby restricts the moves of other investors, who make a move a little later in the day (usually retail investors).

Note:  Circuit breakers are applied in spot market only, for F&O (Future and Options) stocks there are no such restrictions.