Decoded: What are upper and lower circuits in stock markets?

In markets, there are two types of circuit filters – one is at the stock level and the other is market-wide. In this explainer, we will focus on stock-level circuit filters.
 
When a stock moves sharply in either direction – whether up or down – or reaches its maximum permissible tradeable price level for a day, then it’s said to have hit the circuit. In case of an upward movement, it hits the Upper Circuit, whereas in case of a fall, the stock hits the Lower Circuit.
That takes us to the next question, why do we have circuit filters?
 
The role of Circuit filters

• Circuit filters regulate price fluctuation on a day
• They act as market curbs on days of euphoric or panic selling
• They help curb, to an extent, price manipulation by stock operators

 
What are the various daily limits?
A stock, depending on its category, can move by a maximum of 5 per cent, 10 per cent or 20 per cent on either side, on any given trading day.
 
Having said that, the maximum permissible limit for stocks are calculated on the basis of their previous day closing price on exchanges.
 
Here’s an interesting bit you should know. A stock which has hit the upper circuit cannot move any further higher on that day, but the stock can move lower in case there is fresh supply at a lower level than the circuit filter price. Similarly, in the case of the stock hitting the lower circuit, it can’t fall further, but one can buy at the lower circuit since there will be plenty of sellers available.
 
Why do stocks hit circuits?
An individual stock may hit the circuit due to various reasons.
 
For instance, in case of a positive news flow, there could be a high demand for the stock of a particular company, and hence the stock may hit the upper circuit. Likewise, there could be an opposite scenario in case of an adverse news flow.

1. Higher demand for shares than supply: Upper Circuit
2. Higher supply of shares than demand: Lower Circuit

 
Who decides these circuit filters?
The circuit filters are set by market regulator Securities Exchange Board of India, or SEBI, and revised on the basis of market volatility or any unusual activity in certain counters. 
 
These apart, the circuit filters are also revised periodically on the basis of market liquidity. 

• Circuit filters are hiked for stocks with good liquidity
• Circuit filters are lowered for illiquid stocks

 
The periodic adjustments are done to protect investors’ interest in lesser-known stocks.