Just like parents restrict the sugar intake of their children to prevent sugar rushes, the stock market also prevents prices from drastically plunging or soaring in a single day through what are dubbed ‘circuit breakers’.
While everybody knows that volatility is inherent to stocks and sudden price fluctuations can be caused due to a wide range of micro- and macro-economic factors, a certain degree of price regulation in the stock market is necessary. This was first realised after the stock market crash of October 19, 1987, when the Dow plummeted by 22%, and the S&P 500 lost 20.4%. This unexpected stock market crash shook the global stock market, and is known as Black Monday.
After Black Monday, US regulators put circuit breakers in place to act as emergency measures that temporarily halt trading in an attempt to prevent panic-selling and manic-buying. So, how does this circuit breaker system work? And what is the upper and lower circuit in the share market? What should you, as an investor, do when circuit breakers are triggered? Read on to find out.
Table of contents
1. What is the upper and lower circuit?
2. What is the upper circuit in the share market?
3. What is the lower circuit in the share market?
4. Advantages and disadvantages of circuits
5. Recent examples of stocks hitting circuit limits
6. What should you do when circuit breakers are triggered?
7. Frequently asked questions
1. What is the upper and lower circuit?
The upper and lower circuits are limits imposed on benchmark indices and individual stocks by stock exchanges to prevent sharp price movements on any given trading day. The upper circuit is the ceiling price, whereas the lower circuit is the floor price. The circuit limits are applied on the previous day’s closing price.
When an index or a stock hits either the upper or lower circuit, the corresponding circuit breaker is triggered, which prevents investors from placing buy and sell orders for a specific duration. Let’s explore the upper and lower circuit in detail.
2. What is the upper circuit in the share market?
The upper circuit is a pre-determined price limit (expressed as a percentage) that prevents a stock market index or individual stock from increasing beyond a certain maximum point in a single trading session. Upper circuits are important to protect investors from excess upward volatility and maintain the necessary market stability.
2.1 How is the upper circuit limit determined?
Different indices and stocks have different upper circuit limits as decided by the stock exchange and the regulators. For instance, the S&P 500 index can hit the upper circuit at three different levels: 7%, 13%, and 20%. If the index hits the first upper circuit level of 7%, that is, if it rises by 7% in a single trading session, trading will be halted for 15 minutes. For Nifty 50, on the other hand, the three upper circuit limits are 10%, 15%, and 20%.
The upper circuit limit for individual stocks is determined based on factors like market capitalisation and trading volume. For instance, the upper circuit limit for large-cap, mid-cap, and small-cap stocks is different.
2.2 Reasons for hitting the upper circuit limit
The upper circuit limit is typically hit when the demand for a given stock is higher than its supply. This can happen due to a range of reasons. For instance, when a company posts strong earnings or there is some other positive news like a new acquisition deal or a product launch, demand for its stock can increase, pushing up the price and eventually hitting the upper circuit limit.
Speculative buying is another reason. In January 2021, GameStop, now considered a meme stock, hit the upper circuit limit multiple times when a group of Reddit users carried out a coordinated buying campaign.
Market-wide factors can also cause indices and stocks to hit the upper circuit limit. Favourable government policies, strong economic data like GDP growth, and an overall bullish sentiment are some such reasons.
2.3 What happens when a stock hits the upper circuit limit?
When a stock hits the upper circuit limit, trading is halted for a specific duration, usually between 15 minutes to an hour. This duration depends on the percentage increase and on the stock exchange.
During this period, no buy or sell orders can be placed for the stock, and it serves as a cooling period to restrict further price escalation. It also offers investors the opportunity to take some time to assess the valuation of the stock and their investment strategy. Once trading resumes, it does so at a price which is at or below the upper circuit limit.
3. What is the lower circuit in the share market?
The lower circuit is a pre-determined price limit (expressed as a percentage) that prevents a stock market index or individual stock from falling beyond a certain minimum point in a single trading session. It is the opposite of an upper circuit.
3.1 How is the lower circuit limit determined?
Like the upper circuit limit, the lower circuit limit is determined by stock exchanges and regulators, and is different for different indices and stocks based on factors such as trading volumes and market capitalisations.
Like with the upper circuit limits, the lower circuit limits for Nifty 50 are 10%, 15%, and 20%. If the index falls more than 10%, trading is halted for 15 minutes; if it falls more than 15%, the halt lasts 1 hour 15 minutes; and if it falls by more than 20%, then trading is halted for the rest of the trading day.
The lower and upper circuit limits are usually revised by stock exchanges and regulatory authorities depending on market conditions like liquidity.
3.2 Reasons for hitting the lower circuit limit
Whenever there is excess supply but low demand, stock prices face downward pressure and can hit the lower circuit limit. Usually, when there is some significant company-related news that is negative, such as a management scandal or weak earnings, investors might start panic-selling, driving the stock price down rapidly.
Geopolitical events, too, can cause stocks to hit the lower circuit limit. For instance, back in 2016, when the UK voted to leave the European Union (EU) (an event known today as ‘Brexit’), several stocks around the world hit their lower circuit limits.
Unfavourable economic conditions like a recession or a slowdown can also trigger stocks to hit their lower circuit limits. This is because in such conditions, investors tend to become risk-averse and want to exit their equity positions to limit capital losses.
3.3 What happens when a stock hits the lower circuit limit?
Trading is halted when a stock hits the lower circuit limit to prevent panic-selling and protect investors from significant losses. During this period, which can range from 15 minutes to the rest of the trading session, investors cannot place new orders.
Even after trading resumes, there may be certain restrictions for the rest of the trading day. For instance, when trading resumes after the lower circuit is triggered, only buy orders may be allowed at a price above the lower circuit limit.
There are several advantages and some disadvantages to investors of upper and lower circuit limits. Let’s see what they are.
4. Advantages and disadvantages of circuits
Some of the advantages of upper and lower circuits are:
- Prevents panic and manic trading
There is often a herd mentality at play when it comes to the stock markets, and any news or event can cause investors to sell or buy stocks rapidly. The circuit breaker system in the stock market prevents panic selling and manic buying in such situations. This helps stabilise excessive volatility in the market and reduces the risk of systemic shocks.
- Helps investors focus on the long term
Circuit limits can encourage investors to focus on long-term investments by preventing overly large short-term fluctuations. This also protects investors from massive losses.
Some of the disadvantages of upper and lower circuits are:
- Increases volatility
Ironically, circuit breakers can increase volatility because once trading resumes, investors may rush to buy or sell the stock in question. A lot of experts criticise the circuit breaker system for creating artificial volatility and argue that the free market forces of demand and supply, if left alone, would naturally bring about equilibrium.
- Can lead to market manipulation
Upper and lower circuits increase the potential for market manipulation. Traders can attempt to artificially drive up or bring down the prices to trigger the circuit breaker for their benefit. For instance, traders can try to collectively bring the stock price up to its upper circuit limit so that they can sell their shares at a higher price once trading resumes.
There are several examples of stocks and market indices hitting their upper and lower circuit limits. Let’s look at some of them.
5. Recent examples of stocks hitting circuit limits
In October 2020, shares of Reliance Power hit its upper circuit limit of 20%. This happened after the company announced a two-fold jump in its profit for the quarter ended September.
In March 2023, five of the seven listed Adani group stocks hit their upper circuit of 5%, including Adani Green Energy, Adani Power, Adani Transmission, Adani Total Gas, and Adani Wilmar. This happened after the group prepaid loans worth ₹7,347 crore.
An instance of a circuit breaker being triggered due to an index reaching the lower circuit limit occurred when the COVID-19 pandemic broke out in March 2020: the American S&P 500 index dropped 7% on March 9, 12, 16, and 18 in rapid succession.
6. What should you do when circuit breakers are triggered?
When a circuit breaker is triggered, you can use that as an opportunity to reassess your portfolio to see if any of your stocks are impacted and whether you need to rebalance your portfolio.
However, it’s important to not make any hasty decisions based on the current market sentiment alone, as it can lead to a deviation from your long-term investment strategy. When a stock hits its upper circuit, it doesn’t always mean that the stock is valuable and would make for a good investment. The same is true for when a stock hits its lower circuit — this alone cannot be an indicator to exit your position.
You need to assess the company’s fundamentals like earnings, revenue, future prospects, and more to make buy and sell decisions. Another thing to remember is that besides the circuit limits set by the stock exchange, you, as an investor, should have certain upper and lower limits for your stock investments depending on your risk tolerance and financial goals.
Such limits should apply to both your equity allocation in your portfolio as well as the losses you’re willing to bear on individual stocks (which you can control by placing stop-loss orders). When you use an investment platform like Appreciate, you can use such helpful features to customise your investments and maximise your returns. Download the app today!
7. Frequently asked questions
7.1 How are the circuit filters decided?
Circuit filters or circuit limits are decided by the concerned regulatory authority and stock exchange. For instance, in India, the Securities and Exchange Board of India (SEBI) has decided the three levels of the circuit breaker — 10%, 15%, and 20%.
7.2 Can the price of a stock go above the upper circuit?
In a single trading session, the price of a stock cannot go above its pre-defined circuit limit. That is because the minute the stock hits its upper circuit, trading for it will be halted, and no new orders will be accepted during the cooling period. Once trading resumes, it will be at a price that is lower than or equal to the upper circuit limit.
7.3 Can the price of the stock change when a circuit is applied?
Yes, the price of the stock can change when a circuit is applied. When trading is halted for a stock after it hits either its upper or lower circuit, no orders can be placed for it until trading resumes. This can change the price by impacting the demand and supply dynamics once trading resumes. The price can also change due to a change in the market sentiment and investor behaviour as a result of the circuit being triggered.
7.4 Can the upper and lower circuit limits be changed?
Yes, the upper and lower circuit limits can and have been changed several times in response to market and economic conditions and events. For instance, during the outbreak of the COVID-19 pandemic, several stock exchanges around the world changed their circuit limits in an attempt to avoid excessive volatility.
7.5 What is the significance of the upper and lower circuit limits in the share market?
The upper and lower circuit limits in the share market prevent sharp swings in prices in a single trading day. This protects investors from sudden capital losses and maintains the necessary stock market stability.
