What is the meaning of a circuit breaker?
A circuit breaker is a measure designed to halt trading activities on exchanges when the market is experiencing excessive panic and volatility. This regulatory measure applies to indexes and individual securities.
How does circuit breakers work?
Circuit breakers also known as trading curbs work automatically. There are pre-determined levels that trigger the circuit breakers. Exchanges designed these levels in terms of percentages.
The following are circuit breaker levels for the S&P 500. Level 1 and level 2 circuit breakers will not occur if they happen within 35 minutes before the market closes. Sources: economictimes.indiatimes.com, investopedia.com
- Level 1: Level one circuit breaker occurs when the S&P 500 index drops 7% from the previous day close. The halt time for this breaker is 15 minutes.
- Level 2: It takes place if the index loses 13% for the previous day’s close. The duration for this halt will be 15 minutes.
- Level 3: This is an extreme level which takes place when the market loses 20% from the previous day’s close. The market will be completely closed for the remaining trading hours of the day.
Circuit breakers help investors from losing everything when the market is moving wildly. For example, markets experienced extraordinary volatility during the coronavirus. Without circuit breakers, there could have been major losses in the market due to high volatility and panic trading activities.
What happens when the market stays volatile after the circuit breaker?
The main job of circuit breakers is to bring order to the market. In doing so, they protect investors’ capital when the volatility is high.
Panic trading activities are to blame for high percentage losses in the market.
If the market volatility continues after the first circuit breaker, the second breaker will take place. And if the second one cannot calm the market, the third circuit breaker will go into effect. Everything will depend on the percentage of losses in the market.
