• HDFC securities
• 10 Mar 2023
• Knowledge Centre

 

Many times, you might see headlines of certain stocks hitting an upper or lower circuit. This is especially common when the price of a stock is highly volatile due to major events or news releases. Although many traders often keep an eye out for stocks that are about to hit a circuit breaker, it is crucial for one to know what is circuit breaker in stock market.

Stock market circuit breakers are tools that are used to halt trading. Often used as a regulatory measure, the main purpose of a Stock market circuit breaker is to avoid panic selling or manic buying in a particular stock. Apart from stocks, these circuit breakers can be applicable to indices as well.

According to the guidelines issued by the Securities Exchange Board of India (SEBI), index wide circuit breakers are implemented if either the NSE Nifty 50 or BSE Sensex move by 10%, 15% or 20% in either direction. The time limit for which the trading is halted depends on the percentage by which the index moves and at what time of the day these moves are seen.

Why are Circuit Breakers used?

Circuit breakers in share market are crucial to regulating price movements and preventing heavy losses. After the ‘Black Monday’ crash of 1987 in the US, measures were introduced to ensure that investors do not panic sell and cause a market crash. Following this, similar measures were implemented by SEBI in India. Circuit breakers are effective tools to halt trading which can help regulators as well as investors.

How do circuit breakers work?

There are two types of circuits:

• Upper circuit: In this situation, trading is halted after the prices move up by a certain percentage set by the regulators. A stock hits an upper circuit when it has multiple buyers and no sellers.
• Lower circuit: A lower circuit breaker in the stock market occurs when the price of a stock falls by a certain percentage set by the regulators. In this situation, there are only sellers and no buyers for the stock.

Advantages of Circuit breakers:

One of the major advantages of a circuit breaker is that it halts the trading of a particular stock or index and gives the investors, as well as the regulatory bodies, the necessary time to make investment decisions.

Secondly, circuit breakers in stock markets are helpful in order to protect investors from heavy losses by limiting panic-selling that might occur in a market. It also prevents mass accumulation of a stock by implementing an upper circuit breaker.

However, circuit breakers also pose certain limitations. At times, investors might get stuck in a trade where a circuit breaker has been implemented while on the other hand, some traders might benefit by getting in early.

When circuit breakers are implemented, real-time price discovery is not possible. This can lead to volatile price fluctuations and certain orders may get executed at unfair prices.