What are circuit breakers in the Indian stock market?

A circuit breaker is a regulatory tool designed to temporarily halt trading when extreme price movements occur in the stock market. It is an automatic response to prevent excessive volatility and panic-driven decisions by investors.

In India, the Securities and Exchange Board of India (SEBI) oversees circuit breakers. Introduced in 2001 and updated in 2013. This mechanism helps stabilise the market during unusual fluctuations, allowing time for market participants to assess the situation before making further trades. If you are looking to invest in the share market, read along to learn more about the meaning of circuit breakers.

Why is a circuit breaker necessary in the stock market?

Circuit breakers are vital for maintaining orderly market conditions. Stock prices often react to news, both positive and negative, which can lead to sudden and extreme price movements. Without circuit breakers, sharp declines or spikes can cause panic among investors, driving irrational buying or selling decisions.

By implementing these limits, the Indian stock market can prevent market manipulation, safeguard investor interests, and maintain stability. Circuit breakers provide a cooling-off period during which investors can make more informed decisions rather than reacting emotionally to market volatility.

What is the circuit limit in the stock market?

The circuit limit refers to the maximum and minimum price ranges, or bands, within which a stock or index can move on any given trading day. These bands include:

• Upper circuit limit: This refers to the highest price a stock can reach during a trading day. Once this limit is reached, trading is temporarily halted to prevent further price increases. At this point, only sellers can place orders, as no further buying is allowed until trading resumes.
• Lower circuit limit: This is the minimum price at which a stock can be traded on a given day. Once this limit is reached, trading is temporarily suspended, reflecting a situation where sellers dominate the market without any buyers.

When either limit is crossed, a circuit breaker is triggered, and trading halts temporarily to stabilise the market. This mechanism ensures that prices do not fluctuate uncontrollably within a short period, providing a buffer against sudden market swings.

How does SEBI determine the duration of the halt?

The duration of the halt depends on how much the market has moved and at what time the circuit breaker is triggered. SEBI prescribes specific halt durations based on the percentage drop or rise in the market index:

• 10% movement: A halt of 45 minutes to an hour, depending on the time of day.
• 15% movement: Trading is suspended for a longer period, ranging from 45 minutes to the rest of the day.
• 20% movement: Trading halts for the remainder of the trading day.

This structure ensures that market participants have adequate time to analyse the situation and adjust their strategies accordingly.

What are the advantages of circuit breakers in the stock market?

Circuit breakers in the stock market offer multiple benefits to investors, including:

• Reduced panic: By temporarily halting trading, circuit breakers allow investors time to absorb market news and make calm, informed decisions, reducing emotional or panic-driven trades.
• Informed decision-making: Investors get a brief period to analyse the market's performance, news updates, and corporate announcements, enabling more rational decision-making.
• Market stability: Circuit breakers help maintain stability in the face of extreme volatility by preventing sudden and significant price changes within a short period.

What are the disadvantages of circuit breakers?

Despite their advantages, circuit breakers come with a few disadvantages:

• Increased panic: While designed to reduce panic, the sudden halt in trading can sometimes exacerbate anxiety among investors, as they might fear losing the opportunity to sell or buy.
• Artificial price volatility: Circuit breakers may disrupt natural price movements, creating artificial volatility. This can lead to market inefficiencies, as orders tend to pile up at circuit limits.
• Reduced liquidity: Trading halts can affect market liquidity, as investors are unable to trade during these suspension periods, which may limit market functioning.

When have circuit breakers been triggered in India?

Circuit breakers have been triggered multiple times in the Indian stock market. One of the most notable instances occurred during the COVID-19 pandemic in March 2020, when the SENSEX fell by nearly 10%, triggering a circuit breaker. The NIFTY also dropped by 9.40%, leading to trading halts on both the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE).

Another significant event was in 2009, when the Indian stock market surged, triggering the upper circuit limit. This marked the first time the market had breached an upper limit, highlighting the flexibility of circuit breakers in both upward and downward trends.

Invest safely

Circuit breakers in the stock market are a crucial part of India’s financial regulations. They help ensure market stability and protect investors during times of extreme price volatility. While they offer significant advantages, such as reducing panic and stabilising prices, they can also cause temporary inefficiencies by halting trading and preventing real-time price discovery.Whether you invest in the share market or engage in online trading, understanding how circuit breakers work is essential. This knowledge can help you make more informed decisions when navigating periods of market volatility.