Circuit filter, also known as circuit breaker, is a percentage-based regulatory tool which prevents extreme price fluctuations in the stock market with the aim to protect investors from severe volatility. The circuit filter automatically and temporarily shuts the trading when the stocks make a sharp marathon run, either in bullish or bearish direction, within a short span of time and breach a predesignated percentage increase or decrease.
The circuit filter is decided as per the regulations of Securities and Exchange Board of India (SEBI), the regulatory authority which acts as watchdog for stock markets. The circuit filter protects the market from plunging into extreme volatility as it stops panic selling and irrational purchasing of stocks.
When the circuit filter is triggered by a bullish run, it is called upper filter or upper circuit, and on the contrary, when the circuit filter is triggered by a bearish run, it is called the lower filter or lower circuit.
In moments of shock for the stock market, which can be caused by dramatic global developments, sudden outbreak of a crisis, news or rumours, the circuit filter acts as a pause button and provides moments of calm for a cool-headed rethink and strategising.
The circuit filters are separately designated for indices and stocks. In case of the index-based circuit filters, the percentage limits are 10%, 15% and 20%, while stock-based limits are at 2%, 5%, 10%, 15% and 20%.
In case a market-wide circuit filter is triggered, stock exchanges have to mandatorily stop matching of orders and purge all unmatched orders present in the system, thus bringing an effective and immediate halt to the trading. The exchanges also have to ensure that all messages related to market-wide index circuit breakers are given higher priority over other messages.
Why is Circuit Filter Important for Stock Market?
A circuit filter is an important regulatory mechanism which protects the stock markets from plunging into an endless pit of volatility. It limits the percentage of price change during a trading day, thus providing protection to the market from shock falls and price manipulation.
It also protects small investors and novice traders, who either do not keep a regular track of the market or who do not have enough experience to respond to crisis situations.
SEBI Regulations for Index-Based Circuit Filter
SEBI implemented the index-based market-wide circuit filter in 2001, which will be in effect at 3 stages of index movement either way at 10%, 15% and 20%. These filters bring a coordinated trading halt in all equity and equity derivative markets nationwide. The filters are triggered by movement of either BSE Sensex or the NSE S&P CNX Nifty, whichever is breached earlier.
The trading halt triggered by the circuit filter is followed by a 15-minute pre-open call auction session. The circuit filter is calculated on a daily basis by comparing the percentage increase or decrease from the previous day’s closing level of the index.
- 10% circuit filter: When the 10% filter is triggered, the market would halt for one hour if it happens before 1 pm. In case the filter is triggered between 1 pm and 2:30 pm, the trading would stop for 30 minutes. If the 10% breach happens after 2:30 pm, there would be no trading halt.
- 15% circuit filter: If the 15% circuit filter is triggered before 1 pm, the market is shut for 2 hours. In case the 15% filter is triggered between 1 pm and 2:30 pm, the trading is halted for one hour, while there is no halt if the filter is triggered after 2:30 pm.
- 20 % circuit filter: The 20% circuit filter is triggered when the index moves 20% from the previous day’s closing level, and it results in the trading halt for the remainder of the day.
SEBI Regulations for Scrip-Based Circuit Filter
The individual scrip-wise circuit filter is applicable to all scrips in the compulsory rolling settlement and is triggered at 20% movement either way. The SEBI guidelines state that this scrip-based filter is not applicable to the scrips on which derivatives products are available or scrips included in indices on which derivatives products are available.
In addition to the scrip-based circuit filter, stock-specific circuit limits are triggered at 2%, 5%, 10%, and 20%. These percentages are determined by the volatility of the stocks, and these scrip and stock-based filters only halt the trading of that particular stock, not the entire exchange.
Examples of Circuit Filter in India
There are many real-life examples of circuit filters being triggered, which led to a trade halt in India. In 2004, the unexpected results of the Indian general election shocked the markets, which led to the 10% circuit filter trigger.
In March 2020, the outbreak of the COVID-19 pandemic and the unprecedented lockdown of the country panicked the stock market, triggering the 10% circuit breaker. In case of a stock-specific filter, Reliance’s Jio Financial fell 5% on August 23, 2023, triggering trading for the stock.
Conclusion
Circuit filters, or circuit breakers, are a crucial regulatory mechanism that prevents the markets from sliding into excessive volatility and prevents price manipulation. These filters are triggered when the movement of an index, a stock or a scrip makes a sharp bullish or bearish run within a short span and breaches a predetermined percentage change, thus triggering a trading halt.
In case a filter is triggered, the traders and investors should use the trading halt period to make calm calculations and avoid emotional, knee-jerk reactions in either irrational buying or panic selling.
FAQs
What is a circuit filter in trading?
A circuit filter in trading is a regulatory mechanism which halts trading when the index or a stock moves rapidly and breaches a predetermined percentage change.
When is the circuit filter in trading triggered?
The index-based circuit filter is triggered when an index changes 10%, 15% or 20% from the previous day’s closing position. Each of the three triggers leads to a trading halt for different durations, depending on the time of the day when the breach occurred.
Which regulatory body determines the rules and regulations for circuit filters?
The rules and regulations for circuit filters in India are determined by the Securities and Exchange Board of India (SEBI).
What are the benefits of circuit filters?
Circuit filters are crucial in trading as they prevent price manipulation and excessive volatility. It also protects traders and investors from panic selling and irrational buying when sudden events cause a shock in the market, which could cause an index to change erratically.
What happens when an index changes position by 20%?
In case an index changes position by 20%, it triggers a 20% circuit filter and the trading is halted for the rest of the day.
