What Are Circuit Breakers?
Circuit breakers are regulatory measures to temporarily halt in trading on an exchange, which are in place to curb panic-selling. They apply both to broad market indices such as the S&P 500 as well as to individual securities and exist in the United States as well as in other countries.
As recent examples, on March 9, 2020 and again on March 16, circuit breakers were triggered at the NYSE as the DJIA fell more than 7% at the open, amid the growing global coronavirus pandemic.
- Circuit breakers are temporary measures that halt trading, which are used to curb panic-selling on U.S. stock exchanges.
- Currently, U.S. regulations have three levels of circuit breaker, set to halt trading when the S&P 500 Index drops 7%, 13%, and 20%.
- The system of circuit breakers has been revised several times based on feedback from past crises, including the 1987 Black Monday Crash.
What's a Circuit Breaker?
How Circuit Breakers Work
Regulators put the first circuit breakers in place following the market crash of October 19th 1987, when the Dow Jones Industrial Average (DJIA) shed 508 points (22.6%) in a single day. The crash, which began in Hong Kong and soon affected markets worldwide, came to be known as Black Monday.
A second incident, the so-called flash crash of May 6th 2010, saw the DJIA drop almost 1,000 points (over 9%) in just ten minutes. Prices mostly recovered by market close, but the failure of the post-1987 circuit breakers to halt the crash caused the regulators to update the circuit breaker system.
Today, the circuit breaker system applies to both individual securities and market indices. For example, since February 2013 we have had market-wide circuit breakers which respond to single-day declines in the S&P 500 index. If the index falls by 7% below its previous close, this is known as a Level 1 decline. A Level 2 decline refers to a drop of 13%, whereas a Level 3 decline refers to a drop of 20%.
Some analysts believe that circuit breakers are disruptive and keep the market artificially volatile by causing orders to build at the limit level and decreasing liquidity. Critics argue that if the market were allowed to move freely without halts they would settle into a more consistent equilibrium.
For individual securities, circuit breakers can be triggered regardless of whether the price is increasing or decreasing. By contrast, circuit breakers that relate to broad market indices are only triggered based on downward price movements.
Circuit Breaker Timers
Level 1 or 2 circuit breakers halt trading on all exchanges for 15 minutes, unless they are triggered at or after 3:25 PM, in which case trading is allowed to continue. Level 3 circuit breakers halt trading for the remainder of the trading day (9:30 AM to 4:00 PM).
Single Stock Circuit Breakers
In addition to these market-level circuit breakers, there are also circuit breakers for individual securities. Unlike their market-wide counterparts, these individual circuit breakers go into effect whether the price moves up or down. Importantly, exchange-traded funds (ETFs) are treated as an “individual security” under the circuit breaker system, even though they represent portfolios of several securities.
The following table outlines the acceptable trading ranges used to regulate individual securities within the current system of circuit breakers:
|Key Parameters of the Circuit Breaker System|
|Acceptable up-or-down trading range (9:45 am-3:35 pm)||Acceptable up-or-down trading range (9:30-9:45 am and 3:35-4:00 pm)||Security price, listing|
|5%||10%||Tier 1 National Market System (NMS) securities: S&P 500- and Russell 1000- listed stocks, some exchange-traded products; price greater than $3.00 (price > $3.00)|
|10%||20%||Tier 2 NMS securities: other stocks priced over $3.00 (p > $3.00)|
|20%||40%||Other stocks priced greater than or equal to $0.75 and less than $3.00 ( $0.75 ≤ p ≤ $3.00)|
|Lesser of 75% or $0.15||Lesser of 150% (upper limit only) or $0.30||Other stocks priced less than $0.75 (p < $0.75)|
If trading outside of these bands persists for 15 seconds, trading is halted for five minutes. The reference price is calculated using the average price over the previous 5 minutes, and the maximum allowed pause is 10 minutes.
To accommodate the higher volumes generally associated with the opening and closing periods of the trading day, the bands are doubled during those periods (9:30 AM to 9:45 AM and 3:35 PM to 4:00 PM, respectively).
Since October 2013, the SEC has used a “limit-up limit-down” (LULD) mechanism to determine the thresholds for acceptable trading. In this framework, halts are triggered by up-or-down moves outside of certain bands, determined based on the security’s price and listing.