The stock market is inherently volatile, with prices of stocks and indices fluctuating based on a myriad of factors. To manage this volatility and protect investors from extreme market movements, mechanisms known as upper and lower circuits are employed. These circuits act as safeguards, ensuring that the market remains orderly and preventing irrational price swings that can arise from panic buying or selling.
Historically, the concept of circuit breakers was introduced to curb excessive volatility in the stock market. The Securities and Exchange Board of India (SEBI) has been instrumental in implementing these mechanisms. In 2001, they set clear guidelines and regulations for their application. Circuit breakers are particularly important in maintaining market stability, as they provide a cooling-off period during periods of intense market activity, allowing investors to make more informed decisions.
The evolution of circuit breakers can be traced back to significant market events that highlighted the need for such measures. For example, during the 1987 stock market crash, also known as Black Monday, the U.S. stock markets experienced a sudden and severe downturn, leading to the introduction of circuit breakers to prevent future occurrences of such drastic price movements.
What are Upper and Lower Circuits in the Stock Market?
An upper circuit is a predefined limit set by the stock exchange, which prevents a stock from trading above a certain price during a single trading session. This limit is established to curb excessive volatility and protect investors from extreme price movements. For example, if a stock’s upper circuit is set at 10% and it closes at тВ╣100, the maximum price it can reach the next day is тВ╣110. This mechanism is crucial in preventing speculative bubbles and ensuring a more stable trading environment.
Conversely, a lower circuit sets the minimum price limit for a stock during a single trading session, preventing it from falling below a certain threshold. If a stock’s lower circuit is set at 10% and it closes at тВ╣100, it cannot trade below тВ╣90 the next day. This measure helps to prevent panic selling and sharp declines in stock prices, providing a buffer against market crashes.
Factors Influencing Upper and Lower Circuits
Market Sentiment and Psychology
Market sentiment indicates the overall attitude of investors toward a particular security or the stock market as a whole. It is often driven by emotions and psychological factors rather than logical fundamental analysis. For instance, during periods of optimism, investors may drive up stock prices, which can activate upper circuits in specific stocks or even indices. Conversely, during times of pessimism or panic, stock prices may plummet, triggering lower circuits.
Economic Indicators and Corporate Actions
Economic indicators such as GDP growth, inflation rates, and interest rates have a significant impact on stock prices. Positive economic indicators generally boost investor confidence, potentially driving stock prices to their upper circuit levels. On the other hand, negative indicators can lead to a decline in stock prices, which can cause them to hit their lower circuit limits.
Corporate actions like dividends, stock splits, mergers, and acquisitions also play a pivotal role. For example, a company announcing a significant merger or better-than-expected earnings can see its stock price surge and hit the upper circuit. Severely negative earnings reports compared to expectations have also seen panic selling in stocks, causing them to hit their lower circuits. This happened as recently as June 2024, when some shares of the Adani group hit their lower circuit.
Regulatory Announcements and Global Events
Regulatory changes and announcements by bodies like the Securities and Exchange Board of India (SEBI) can lead to significant market movements. New policies or regulatory measures can impact investor sentiment, leading to price swings that trigger upper or lower circuits. Global events such as geopolitical tensions, pandemics, and major economic shifts also contribute to market volatility.
Application of Upper and Lower Circuits
Circuits for Individual Stocks
Upper and lower circuits are crucial tools for managing price volatility in individual stocks. These circuits are applied to prevent extreme price swings within a single trading session. For instance, if a stock’s price is rapidly increasing or decreasing due to speculative trading or market rumours, the circuit breakers will halt trading once the price reaches a pre-set limit. This mechanism ensures that stock prices remain within a reasonable range, providing a safeguard for both investors and the market as a whole. For example, in April 2020, Tata Motors hit its upper circuit limit, so trading of that stock was paused to prevent further speculative buying.
Circuits for Market Indices
Market-wide circuit breakers are implemented for major indices like the BSE Sensex and Nifty 50. These circuit breakers are triggered by significant movements in the index value, such as a 10%, 15%, or 20% change. When an index hits one of these thresholds, trading is halted across all equity and equity derivative markets nationwide. This coordinated halt allows the market to stabilise and prevents widespread panic selling or buying.
The table below from the NSE outlines the trigger limits, trigger times, market halt durations, and pre-open call auction session durations following the market halt.
| Trigger Limit | Trigger Time | Market Halt Duration | Pre-Open Call Auction Session Post Market Halt |
| 10% | Before 1:00 PM | 45 Minutes | 15 Minutes |
| At or after 1:00 PM up to 2:30 PM | 15 Minutes | 15 Minutes | |
| At or after 2:30 PM | No halt | Not applicable | |
| 15% | Before 1:00 PM | 1 hour 45 minutes | 15 Minutes |
| At or after 1:00 PM before 2:00 PM | 45 Minutes | 15 Minutes | |
| On or after 2:00 PM | Remainder of the day | Not applicable | |
| 20% | Any time during market hours | Remainder of the day | Not applicable |
Source: NSE Circuit Breakers
This limit applies to both NSE Nifty50 and BSE Sensex 30 as soon as either of them hits one of the circuit limits.
Market-Wide Circuit Breakers
Market-wide circuit breakers are mechanisms designed to halt trading across all equity and equity derivative markets when a significant decline in major indices such as the BSE Sensex or Nifty 50 is observed. These circuit breakers are essential tools for maintaining market stability during periods of extreme volatility. They provide a pause in trading, allowing investors to absorb information and make informed decisions, thereby preventing panic-driven selling or buying.
Market-wide circuit breakers are implemented based on guidelines set by the Securities and Exchange Board of India (SEBI). These guidelines specify three trigger limits: 10%, 15%, and 20%. When these limits are breached, trading halts for a specified duration, depending on the time of the breach and the percentage decline.
Differences Between Stock-Specific and Market-Wide Circuit Breakers
While stock-specific circuit breakers apply to individual stocks, market-wide circuit breakers are triggered by significant movements in major indices. This broader application is designed to prevent systemic risk and ensure the overall stability of the financial markets. Stock-specific circuits protect against extreme price movements in single securities, whereas market-wide circuits address broader market concerns, providing a comprehensive safeguard during times of widespread economic or financial stress.
Essential Facts and Figures about Upper and Lower Circuits
Calculation of Circuit Limits
The calculation of circuit limits is based on the previous day’s closing price. The stock exchange determines the upper and lower limits by applying predefined percentages to this closing price. Common percentage limits are set at 10%, 15%, and 20%.
Regulatory Framework and SEBIтАЩs Role
The Securities and Exchange Board of India (SEBI) plays a pivotal role in the implementation and enforcement of circuit breakers. SEBI’s guidelines ensure that these mechanisms are applied consistently across the market to maintain stability.
Trading Halts, Durations, and Resumptions
When a stock or index hits its upper or lower circuit limit, trading is halted for a specific duration. The length of the halt depends on the percentage limit that has been breached.
Impact on Market Liquidity and Investor Confidence
Circuit breakers significantly impact market liquidity and investor confidence. By preventing extreme price movements, they ensure that the market remains liquid and that trades can be executed in an orderly manner after a halt.
How Investors and Traders Can Take Advantage of Circuit Breakers Effectively
Savvy investors have been able to take advantage of stocks hitting their circuit limits in the past. Here are some strategies that you as an investor can use to make circuit limits work to your advantage. But be very, very careful when using these strategies. Some of these are counter-intuitive, so they need you to have some conviction and logical reasoning behind your decisions.
Monitoring Circuits for Informed Trading
Investors can use various tools and platforms to monitor circuit limits and stock price movements in real-time. Staying updated with market data helps investors anticipate potential trading halts and make informed decisions.
Setting Stop-Loss Orders
Setting stop-loss orders is a crucial risk management strategy, especially when trading near circuit limits. A stop-loss order automatically sells a stock when it reaches a predetermined price, helping investors limit potential losses.
Identifying Investment Opportunities
Circuit breakers can present unique investment opportunities. When a stock hits its lower circuit, it may indicate that the stock is undervalued, providing a chance for investors to buy at a lower price.
Avoiding Herd Mentality
It’s crucial for investors to avoid the herd mentality, especially during periods of high market volatility. Following the crowd blindly can lead to poor investment decisions and significant losses.
Conducting Due Diligence
Conducting thorough due diligence is essential for making informed investment decisions. This involves researching a company’s fundamentals, financial health, management team, and market conditions. Only then can you reach a conclusion on whether or not the significant price rise or fall is justified or not, and take a view accordingly.
Conclusion
Upper and lower circuits are essential mechanisms in the stock market designed to curb excessive volatility and protect investors from extreme price movements. By setting predefined price limits, these circuits ensure that trading remains orderly and that the market does not experience irrational swings driven by panic or speculation. These mechanisms help maintain market stability, protect investor confidence, and ensure a fair trading environment.
Understanding how these circuits function is crucial for anyone involved in the stock market, from individual investors to large institutional traders. By leveraging the information and strategies discussed, investors can navigate market volatility more effectively and make informed decisions that align with their investment goals.
Frequently Asked Questions (FAQs) about Upper and Lower Circuits
What triggers an upper circuit in the stock market?
An upper circuit is triggered when a stock’s price reaches a predefined percentage increase from the previous day’s closing price. This percentage limit is set by the stock exchange and typically ranges from 10% to 20%. When this limit is reached, trading in the stock is halted to prevent excessive speculation and maintain market stability.
How is a lower circuit limit determined?
A lower circuit limit is determined similarly to an upper circuit. It is a predefined percentage decrease from the previous day’s closing price, set by the stock exchange. When a stock’s price falls to this limit, trading is paused to prevent panic selling and stabilise the market. Common lower circuit limits are also in the range of 10% to 20%.
Can I trade when a stock hits the upper circuit?
No, when a stock hits its upper circuit, trading is halted for a specified duration. During this halt, no further buying or selling can occur. The trading halt allows the market to cool down and prevents further speculative buying.
What are the risks of buying at the upper circuit?
Buying at the upper circuit can be risky because the stock price has already reached its maximum allowable increase for the day. There is a possibility that the price may not sustain these levels and could fall in subsequent trading sessions. Investors should carefully analyse the reasons behind the price increase before making a decision.
How does a market-wide circuit breaker differ from stock-specific circuits?
Market-wide circuit breakers apply to entire indices, such as the BSE Sensex or Nifty 50, and are triggered by significant movements in the index value (e.g., 10%, 15%, 20%). These halt trading across all equity and equity derivative markets nationwide. In contrast, stock-specific circuits apply only to individual stocks and halt trading for those specific securities.
What happens if an index hits its circuit limit?
If an index hits its circuit limit, trading in all equity and equity derivative markets is halted for a specified period, depending on the percentage decline and the time of day. This coordinated halt allows the market to stabilise and prevents widespread panic selling. The duration of the halt varies, with longer halts for more significant declines.
How can I protect my investments during extreme market volatility?
To protect your investments during extreme market volatility, consider setting stop-loss orders to limit potential losses. Additionally, stay informed about market conditions and circuit limits, and avoid making impulsive decisions based on market panic. Conduct thorough research and due diligence before making investment decisions.
Are upper and lower circuits effective in preventing market manipulation?
Yes, upper and lower circuits are effective in preventing market manipulation by curbing excessive price movements and providing a cooling-off period. These mechanisms help maintain market stability and protect investors from irrational market behaviour driven by speculation or panic.
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