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Understand Stock Exchange Circuit Breakers
June 06 , 2012

Free markets work on the ideal of price discovery. Share prices reflect not only a company's performance but also investors' views and expectations about it. While performance is measurable and can be forecasted with reasonable accuracy, people's sentiments is hard to predict and at times cannot be justified by reason. Therefore market regulator SEBI has put in place a mechanism to ensure that in a trading session prices don't move beyond what can be said to be supported by logical reason.

What are circuit breakers?

Circuit breaker is a measure enforced by stock exchanges to restrict trades of a share or index when there is tremendously large price movement in a single trading day. Circuit breakers work at index level and individual share level. Trigger price levels and trade halt time are prescribed by SEBI and are followed on the NSE and BSE.

In India a tremendous fall or even rise in price can trigger circuit breakers. In many countries only a fall activates circuit filter. Circuit breakers are in place for all securities. Circuit breaker that gets triggered when price has risen is called an upper circuit and circuit breaker that gets triggered when price has fallen is called a lower circuit.

How do circuit breakers work?

Like circuit breakers in some electronic devices that block unwanted frequencies, circuit breakers stop prices from moving very steeply in any direction in a short span of time. When price of a share or index leaps and touches a prescribed level, circuit breaker is automatically triggered. This halts trading of the share or all shares on the index for a set time.

1. Index level circuit breaker

On the index level circuit breakers are applicable to both cash trades and derivative trades of equity shares. Since some shares are common on both Sensex and Nifty there is a market wide circuit breaker which gets triggered in whichever index crosses the price level first. There are three levels of prices at which circuit breaker would get activated. The prices are calculated with index closing value as on the previous trading day as base.

Level 1 circuit breaker- 10% movement in either index

  • If breached before 1 pm there would be a trading halt of 1 hour.
  • If breached between 1 pm and 2.30 pm there would be a trading break of half an hour.
  • If breached after 2.30 pm there would be no trading halt.

Level 2 circuit breaker- 15% movement in either index

  • If breached before 1 pm there would be a trading halt of 2 hours.
  • If breached between 1 pm and 2.30 pm there would be a trading halt of 1 hour.
  • If breached after 2.30 pm trading would be halted for the rest of the day.

Level 3 circuit breaker- 20% movement in either index

  • If any of the indices cross 20% of the closing price as on last trading day at any time trading will be stopped on that index for the rest of the day.

After the halt, trading first resumes in the Cash Market segment of the exchange with a fifteen minutes pre-open call auction session.

2. Individual security level price filter

Price filter does not apply for stocks on which derivatives are available or those stocks on indices like sensex and nifty which have derivative products.

On all other securities a 20% filter is applicable. In addition stocks exchanges may have filters at 2%, 5% and 10% level. Circuit breakers for individual securities are displayed on BSE and NSE website.

Why are circuit breakers in place?

When prices rise or fall freakily it could be as a reaction to some sensitive news or incorrect punching by a broking staff or even a technical glitch on the exchange's network. Extreme volatility is most damaging to retail investors than other big investors. So whenever there is abnormal rise or fall in prices investors need to be given time to recollect and evaluate what is causing the steep price movement and react with sanity. Otherwise fear and panic can cause slaughter on the markets.

From past instances where markets were halted it has been observed trading resumed to normal when markets resumed from the halt. Some might recall the recent freak trade by a staff at Emkay Global in October 2012 who placed erroneous orders that saw Nifty fall by 15.5% and triggered the market wide circuit breaker. As soon as markets resumed after the halt trades became normal. In the absence of such measures retail investors could be big victims.

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