Financial markets suffered a lot from the global pandemic and the whole stock market was in a frenzy when in March 2020, the government announced nation-wide lockdown, the market fell drastically and halted for 45 minutes as Sensex dropped by 3250 points and Nifty by 7798 points thereby triggering the 10% lower circuit breaker.
This wasn’t an ordinary phenomenon and the traders who were new to the market were quite confused at the sudden halt. For people who read the news later in the day this term was completely bizarre for them too.
A circuit breaker can be quite a complex term for someone unfamiliar with stock trading. So, if you are trying to enter the market then first you should acquaint yourself with the terminology of it and in these uncertain times, circuit breakers are something that you should definitely know about.
What exactly is a circuit breaker?
It is nothing but a break or a temporary halt in the market to prevent the panic selling or buying of stocks for a short period. It can be triggered by an unusual price rise or fall in the market.
The basic job of a circuit breaker is to stop the panic so that the market doesn’t encounter any drastic plunge or surge. These circuit breakers are established by the regulatory board of the stock exchanges which in the case of India is SEBI (SECURITIES EXCHANGE BOARD OF INDIA).
They can be further identified into upper and lower circuit breakers.
When the price rises at an alarming rate and breaches the upper limit set by the Indian stock exchanges (NSE & BSE), then the upper circuit breaker kicks in and halts the trade depending upon the rate of surge. And when the price goes negative and surpasses the pre-decided lower limit, then the lower circuit breaker is used to stop the trade for a certain amount of time.
Why do we need a circuit breaker?
A circuit breaker works as a safety mechanism established to prevent any wild fluctuations in the market during the trading hours. These circuit breakers mostly come into the picture when there’s some panic news floating around which induces the investors and traders and results in a mass selling/buying of shares.
For example, when the news about COVID 19 and the lockdown started to hover around the market, it created hysteria in the market and thus the market plunged severely leading to the implementation of circuit breakers.
To understand the concept of circuit breakers better, one should know about its different types or levels.
An index-based Market-wide circuit breaker system is established by SEBI, which bring a market-wide halt to the equity trade. These circuit breakers are triggered by the unprecedented movement of either Nifty or Sensex, whichever falls or rises first.
The 3 circuit breaker levels are 10%, 15% and 20% which are executed anytime between 9:15 am to 3:30 pm (official trading hours) in the following manner:
|Market halt duration|
|Pre-open call auction session post-market halt|
|BEFORE 1 PM||45 MINUTES|
|AFTER 1 PM AND BEFORE 2:30 PM|
|AFTER 2:30 PM||NO HALT FOR THE REST OF THE DAY||NOT APPLICABLE|
| BEFORE 1 PM|
|1 HOUR 45 MINUTES|
|AFTER 1 PM AND BEFORE 2 PM||45 MINUTES||15 MINUTES|
|AFTER 2 PM|
|NO HALT FOR THE REST OF THE DAY||NOT APPLICABLE|
|20%||ANY TIME DURING THE MARKET HOURS|
|NO HALT FOR THE REST OF THE DAY|
How is a circuit breaker applied?
Although it sounds very technical, it’s very easy to understand. As we mentioned earlier circuit breakers can be applied at 3 levels but how do these levels actually work?
10% circuit breaker: A halt of 45 minutes is applied in the market before 1 PM if the movement in the market is 10%. But if the fluctuations happen after 1 PM and before 2:30 PM then a halt of 15 minutes is applied. No halt is applied if there’s any movement after 2:30 PM.
15% circuit breaker: If there is 15% fluctuation in the market before 1 PM then a halt time of 1 hour 45 minutes is applicable. But if movement happens after 1 and before 2 then the market halts for a solid 45 minutes. After 2:00 PM no halt is applied for the rest of the day.
20% circuit breaker: If a fluctuation as big as 20% happens in the market at any time of the day, the stock exchange halts for the entire day and only opens the next.
What happens after the trading halt is over?
After the breach in the circuit i.e. dramatic price-fall or rise in the market, the market reopens with a pre-open call auction session of 15 minutes post the duration of the halt in specific circuit breaks. Here, before reopening the exchanges call the buyers and sellers to bid on stocks which allows them to set the prices of those stocks rationally for the reopening of the trade. Market re-opens at the price determined from the call-up session bidding. The normal trading will begin and continue as long as another circuit isn’t breached.
Advantages of circuit breaker
- A circuit breaker gives time to the investor to rethink his decisions and let the market settle down. Sometimes these fluctuations are manipulated and not real participant’s trade. The halt duration gives the investor enough time to go through the news and announcements and gather the facts.
- It reduces huge fluctuations as it gives time to settle and calm down the overreactions caused by panic.
Disadvantages of circuit breaker
- Real-time price movements aren’t possible in a circuit breaker. Thus, one can’t determine the real-time price during the halt time.
- The investor/ traders might take advantage of the market if they get access to any future news or announcements before the circuit breaker kicks in, while those who are late don’t get the opportunity due to the market-halt.
Now you know all about a circuit breaker and how it works. So, the next time the market shows a dramatic fluctuation you will know what’s going to happen and will not be the clueless one this time.