What is a circuit breaker in a stock market; how does it work?

Sell-off continued when the Indian markets opened for trade on Monday. The headline index S&P BSE Sensex tumbled nearly 3,000 points within the first 45 minutes of Monday's session as more countries went into a lockdown to stem the spread of fast-spreading novel coronavirus (COVID-19). In India, various state governments announced lockdown in nearly 80 districts across the country as the total number of confirmed Covid-19 cases inched towards 400.
 

Trading on the Indian stock exchanges was halted as the S&P BSE Sensex fell 10 per cent, triggering an automatic 45-minute halt. It was the second instance of trading halt in the Indian market in a span of 10 days. Earlier, in March 13, Nifty hit lower circuit in the opening deals for the first time since May 2009.

At 10:26 a.m., the S&P BSE Sensex was down 10 per cent at 26,928.38 and the Nifty50 index fell 842 points, or 9.63 per cent, to 7,903.
 

So, what is a circuit breaker or filter?

A circuit breaker is a measure to stem the steep fall or a sharp rise in the price of a security / stock or the index as a whole.

The concept was first introduced back in 1987, when the market crash of October 19, 1987 sent the Dow Jones Industrial Average (DJIA) tumbling 508 points, or 22.6 per cent in a single day. The incident is popularly known as Black Monday, as this rout in US equities triggered a global sell-off.

Back home, Indian stock exchanges implemented index-based market-wide circuit breakers with effect from July 2, 2001. Some modifications were made in September 2013.

The system applies at three stages of the index movement, either way, at 10 per cent, 15 per cent and 20 per cent. These breakers, when triggered, bring about a coordinated trading halt in all equity and equity derivative markets. (See Table; Table Source: NSE)

The market-wide breakers are triggered by a movement of either the S&P BSE Sensex or the Nifty50, whichever is breached earlier. The exchanges compute the Index circuit breaker limits on a daily basis, based on the previous day’s closing level of the index.

In case of illiquid securities or as a price containment measure, the circuit filters, according to BSE, are reduced to 10  per cent or 5  per cent or 2 per cent as the case may be, based on the criteria decided by the Surveillance Department. However, No circuit filters are applicable on Securities on which derivative products are available. That said, BSE imposes 10 per cent dynamic circuit filter on these Securities to avoid punching errors, if any.

circuit breaker chart