Home » What are circuit filters in stock markets and how do they work?

What are circuit filters in stock markets and how do they work?

What are circuit filters in stock markets and how do they work?

Photo courtesy Mohamed_Hassan on Pixabay.

A stock can move either way, up or down, and reach its maximum or minimum tradable price for the day. When it reaches its maximum upper price it is said to have hit the upper circuit and it can’t go up any further. In case it falls and reaches its minimum tradable price for the day, it is called the lower circuit. The stocks depending on their category can move either up or down by a maximum of 5%, 10% or 20%, and the limits are calculated based on their closing price of the previous day.  So the circuit filter or circuit breaker is the band within which an individual stock or an index can fluctuate in a day. SEBI is always carrying out work to protect small investors. Circuit filters are a form of market curbs put in place by the regulatory authority to protect investors or traders.

A stock may hit a circuit filter depending on various reasons. The price of a stock depends on the demand and supply and any situation that changes the preference for a share can lead the stock to hit its circuit limit, which may be the upper or the lower limits. Sometimes the manipulation of a stock can also lead them to hit their circuits.

Some of the reasons why the stocks can hit an upper or lower circuit are good or inadequate earnings, political uncertainty, change in interest rates, geopolitical pressure, fiscal expansion or consolidation, or change in investor confidence depending on the rise or fall in foreign stock markets.

When the stock price hits the upper circuit there is plenty of buyers and no sellers so a person can sell a stock easily at the upper circuit. The stock can move lower in case there is a fresh supply at the lower levels as compared to the upper circuit price. Similarly, when the stock hits the lower circuit there are plenty of sellers but no buyers, so one can easily purchase at that price.

As the stocks have circuit filters, the same way stock market index too has circuit filters. The index-based circuit breaker applies at three stages of the index movement either way at 10%, 15%, and 20%. The circuit breaker when applied brings about a coordinated halt to the trading in the equity and the derivative market in the country.  A circuit breaker is applied in the Indian stock markets if either the BSE Sensex or the Nifty 50 breaches the limit. The market will reopen after an index-based circuit filter breach and the limit of market halt is as given below-

The index level circuit breaker limits are computed by the exchange for 10%, 15%, and 20% levels on a daily basis and are based on the previous day’s closing levels.

The market reopens after the breach of an index-based circuit filter with a pre-open call session of 15 minutes and normal trading continues until the next circuit limit breach does not happen.

The stocks and indices move on the basis of news and any positive and negative news can move the stocks and index by a great amount. The volatility always puts the small investors and traders who have less money at a disadvantage, and to avoid extreme volatility the circuit breakers are there in the Indian stock market as well as stock markets around the world. The upper circuit limit helps so that the stock does not move up indefinitely. Without a circuit breaker, the stock can fall to any level in a single day thus wiping out the investors’ amount. The circuit filters protect small investors and brokers from unwanted movement in stock prices.

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