What happens when a circuit breaker is put into effect?

By Albert Phung AAA
A:

A circuit breaker represents a situation where the Securities and Exchange Commission (SEC) and National Association of Securities Dealers (NASD) have announced a market-wide (includes NYSE, NASDAQ and OTC securities) trading halt in the event of a substantial one day decline in the value of the Dow Jones Industrial Average (DJIA). This measure was put into place to give investors and traders a moment of time to calm down, and prevent the Dow from dropping even further as a result of panic selling.

More specifically, there are actually different circuit breakers depending on whether the Dow has fallen 10%, 20% or 30%. Since the value of the Dow changes over time, each of these trigger points are re-adjusted in order to be representative of those predefined proportions. As of December 2006, the actual point values corresponding to these trigger points is 1,100, 2,250 and 3,350.

The size of a drop is one factor that influences the length of the trade halt duration; the larger the decline, the longer the trading halt. For example, a 10% decline in the Dow would warrant a one-hour trade halt in most situations, whereas a 30% decline would cause an end in the trading day.

The second factor plays into the length of the halt is the specific time of the day in which the decline occurs. The various organizations have created this rough guide as to how long a trade halt would be during different times of the day.

-- Before 1pm 1pm - 1:59pm 2pm - 2:30pm After 2:30pm
10% Decline in the DJIA (Level 1 Halt) 1 Hour Halt 1 Hour Halt 30 Min. Halt No Halt
20% Decline in the DJIA (Level 2 Halt) 2 Hour Halt 1 Hour Halt Market closes Market closes
30% Decline in the DJIA (Level 3 Halt) Market closes Market closes Market closes Market closes
Source: NYSE Group

For example, the Dow fell 12% at 10:00 a.m., there would be a market-wide halt from 10:00 am to 11:00 am (One hour trade halt). However, if the Dow were to fall another 10% at 11:00 a.m. (a total decline of 22%), then a market wide halt of two hours would happen.

This not to say that the markets only halt trading in the face of a large decline. Material events can also cause the markets to be closed for an indefinite period of time, even if the Dow has technically not reached a level 1 halt condition. For example, as a result of the terrorist attacks on September 11, 2001, trading was halted for about a week.

To learn more about panic selling, see Panic Selling - Capitulation Or Crash? and Profiting From Panic Selling.

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