Everyone has dreamed of selecting a stock and earning returns of 50%, 100%, or even 1,000% within a short span of investing in the stock, the best case scenario would be stock price rising by a considerable margin the same day a person invests in it. Regrettably, ‘circuit breakers’ will not let this materialize. The upper and lower circuits are decided by the Securities and Exchanges Board of India (SEBI) in India.
Here, in this blog, we explain what upper and lower circuits are, how stocks might reach them, and what happens when stocks or indices hit the circuits and what you should do in such situations if you are tracking stock market live.
What Does Upper Circuit Mean In Stock Trading?
The upper circuit is the highest price point beyond which a stock’s price or an index’s value cannot increase in value in one day. Stocks that have a lot of buyers but few sellers could reach the upper circuit. Upper circuits are computed using the closing price from the previous day.
Depending on the rules and regulations promulgated by the stock exchange and SEBI, the upper circuit limit may be 20 percent, 10 percent, or 5 percent of the previous day’s closing price for a particular stock. For instance, the stock exchange may impose a circuit limit of 20% on the previous day’s closing price if a stock violates its upper circuit for the first time. The limit can then be successively reduced to 10% or 5% to curtail excessive trading activity if it keeps hitting its upper circuit. The same approach also applies to the stock’s lower circuit restrictions.
The price of a stock cannot increase in a single trading session above its upper circuit. However, if some start selling, the prices can fall. It is very important to be clear with the concept of upper circuit if you are a stock market trader especially if you trade in futures and options.
What Does Upper Circuit Mean In Stock Trading?
The lower circuit is the lowest price point that a stock’s price or an index’s value may hit. Stocks that many people want to sell but that hardly anyone is buying could fall in price. Lower circuits are likewise computed using the closing price from the previous day, they may vary from stock to stock. While the lower circuit for some companies may be 2 percent less than the previous closing price, it could also be 5 percent, 10 percent, 15 percent, or even 20 percent less for other equities. In a single trading session, a stock’s price may not drop below its lower circuit, but if investors start purchasing the stock, its price may rise.
What Causes Stocks To Hit the Higher or Lower Circuits?
Let’s look at some examples of stocks touching the upper or lower circuit to have a better understanding of the reasons why stocks may do so. Consider a scenario in which a new mobile company unexpectedly surpasses the market leader in terms of market share, resulting in a spike in demand for its stock. Such a company’s stockholders are not likely to sell their shares. However, buyers may offer higher prices for these stocks. Upper circuits can shield investors from volatility and unwarranted speculation like the pump-and-dump scandal wherein unscrupulous traders artificially inflate the price of a stock to raise its price and then dump the stock, preventing a stock’s price from rocketing in a single day.
Lower Circuit Illustration
Let’s say there is news that a specific business was engaging in fraudulent business practices. The government is anticipated to take harsh action against this company. The shares of this corporation are now undesirable. As no one would be interested in purchasing, the current stockholders will not be able to sell their shares. A stock’s price may decrease if no one is purchasing it. The stock price may continue to decline due to investors’ concern of buying stocks that are already in decline. Lower circuits are set in order to avoid this.
In 2020, the price of Yes Bank Limited fell rapidly. This was because of issues in respect of management, non-performing assets, and the inability to raise capital.
What Causes The Stocks To Hit Circuit Limits
We frequently hear that supply and demand factors influence stock prices. Therefore, in theory, a stock could reach its circuit boundaries as a result of any occurrence that alters how desirable a stock is. A stock must see a significant change in appeal for it to reach the upper or lower circuit. Market manipulation occasionally also results in equities hitting their upper or lower circuits. If you are watching stock market live you may observe that a stock may hit its upper or lower circuits as a result of the following circumstances:
- Earnings that exceed or fall short of forecasts.
- Political ambiguity.
- Geographic pressures.
- Investor confidence shifts brought on by precipitous drops or gains in overseas stock markets.
- Alteration of interest rates.
- Expansion or consolidation of the budget.
- Revisions to the trading scenario (trade agreements, economic zones, tariffs, etc.).
- Competitors’ superior or inferior performance
What Does Market-Wide Circuit Breakers Mean In Stock Trading?
When market-wide circuit breakers are activated, all equities and equity derivative markets in India come to a coordinated halt. Circuit breakers suspend trading on the NSE and BSE at three points in the movement of their respective indices.
|Change In BSE Sensex Or the Nifty 50 (Positive or Negative)||TRIGGER TIME||MARKET HALT DURATION|
|10%||Before 1:00 PM||45 Minutes|
|At or after 1:00 PM upto 2.30 PM||15 Minutes||15 Minutes|
|At or after 2.30 PM||No halt||Not Applicable|
|15%||Before 1 PM||1 hour 45 minutes|
|At or after 1:00 PM before 2:00 PM||45 Minutes||15 Minutes|
|On or after 2:00 PM||Remainder of the day||Not Applicable|
|20%||Any time during market hours||Remainder of the day|
Following each pause, the NSE and BSE both resume trading with pre-open call auction sessions.
Circuit restrictions are established to shield investors from unwarranted volatility and speculation. Ideally, the price of the stock should only reach the lower and higher circuits when there is a shift in its desirability. However, market manipulators may occasionally attempt to affect the supply and demand for a stock. Investors should use caution when entering trades based only on the fact that equities or indices have reached their upper or lower circuits.
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