What is Circuit in Share Market?

It is widely acknowledged that stock markets exhibit inherent volatility, frequently resulting in significant investor losses due to unexpected price fluctuations. In response to this concern, the Securities and Exchange Board of India (SEBI) implemented circuit breakers, both upper and lower, which establish predefined maximum and minimum price levels. These levels serve to regulate the extent of stock price movements within a single trading day, thereby aiming to protect the interests of investors. 

Upper circuits indicate a situation in which there is greater demand for shares than supply, while lower circuits signify an abundance of shares in the market than demand. In India, SEBI holds sole authority over circuit filters in the stock market. When a stock reaches its upper circuit, there are only buyers and no sellers in the market. 

What is the circuit limit in the share market?

In the stock market, a circuit limit, also known as a price limit or trading limit, is a mechanism designed to prevent excessive volatility in the prices of individual stocks. Circuit limits are set by stock exchanges to regulate how much a stock's price can fluctuate within a single trading session. Stocks typically commence trading with a circuit limit of 20%, indicating that the maximum permissible price fluctuation for the day is set at 20% of the preceding day's closing price of the stock. When a stock reaches its upper circuit, it signifies that the stock's price has surged by the maximum limit permitted for that trading session.

A circuit limit or a circuit breaker is defined as the limit either upper or lower, a stock could rise or fall, before the trading of the stock is halted depending upon the time the circuit filters hits the stock market. The Securities and Exchange Board (SEBI) has defined various circuit levels namely 2%, 5%, 10%, and 20%. These values are applied to the last traded price of the stock of the previous day.

A circuit limit, also known as a circuit breaker, defines the limit, as either upward or downward, at which stock trading is suspended. This is determined based on predefined percentages established by regulatory bodies such as the Securities and Exchange Board (SEBI), which have stipulated several circuit levels, including 2%, 5%, 10%, and 20%, which are applied to the closing stock price from the previous trading day.

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Upper and Lower Circuits for Indices

Additionally, the Indian stock market imposes upper and lower circuits not only on individual stocks but also on stock indices. A stock index serves as a benchmark, reflecting the collective performance of a specific group of stocks in a given market. Notable examples of stock indices in the Indian market comprise the BSE Sensex and the NSE Nifty 50. 

In India, a circuit breaker is triggered when the index undergoes a 10%, 15%, or 20% increase or decrease. If the index experiences a 10% movement after 2:30 pm, trading will continue, since end-of-day trading tends to be more volatile. However, if the movement occurs between 1 pm and 2:30 pm, trading will be paused for 15 minutes. If the movement happens before 1 pm, trading will be suspended for 45 minutes. 

In the event of a 15% movement in the index, trading protocols dictate specific suspension durations based on the timing of the occurrence. Should such movement take place after 2:30 pm, trading will be halted for the remainder of the trading day. If the movement occurs between 1 pm and 2:30 pm, trading will be suspended for 45 minutes. In instances where the movement transpires before 1 pm, trading will be suspended for 1 hour and 45 minutes.

The implementation of a circuit breaker system mandates the suspension of trading for the entire day if the index undergoes a 20% ascent or descent at any point within the trading session. This mechanism serves to mitigate excessive market volatility, safeguard investors against substantial losses, and allow them to re-evaluate their investment strategies.

How to use circuits or price bands on stocks

Here is how you can use circuits or price bands on stocks:

Understanding: Familiarize yourself with the circuit breaker rules and price band limits set by the relevant stock exchange. Different exchanges may have different rules.

Monitoring: Keep an eye on the price movements of the stocks you are interested in. If a stock approaches or breaches the circuit breaker or price bands, be prepared for potential trading halts or restrictions.

Risk Management: Integrate circuit breakers and price bands into your risk management strategy. Understand how these mechanisms can affect your trading decisions and be prepared to adjust your strategies accordingly.

Regulatory Compliance: Ensure that your trading activities comply with the regulations and guidelines set by the relevant regulatory authorities and stock exchanges.

Adaptability: Circuit breakers and price bands are designed to promote stability, but they can also impact market liquidity and trading strategies. Adjust your approach as needed to navigate these changes effectively.

Conclusion

Stock exchanges implement circuits to protect investors from excessive market volatility. Investors need to have a clear understanding of upper and lower circuits and how they function to make informed decisions and manage risks. Although circuits can restrict trading opportunities, they can also present profitable prospects when utilized effectively. By staying updated on the latest market trends and news, investors can identify circuit limits for individual stocks and make well-informed decisions based on this knowledge.