The stock market is a constantly changing landscape, where prices fluctuate based on a wide range of factors, from economic indicators to corporate earnings reports. For investors, this can be both exciting and nerve-wracking, but what if the prices rise or fall suddenly?
That’s where upper circuits and lower circuits come into play. These important market mechanisms help to manage volatility by limiting how much a stock’s price can move in a single trading session.
In this blog, we’ll take a closer look at what are circuit limits, what causes stocks to hit circuit limits and how to find the circuit limit for the stocks you want to track.
What are circuit limits?
In most modern households, electric circuit breakers are installed to prevent electrical devices from getting damaged due to excess current.
If the circuit breaker detects excessive current, it stops the flow of current and safeguards our electrical appliances, ensuring that there are no accidents or undue losses.
Similarly, to avoid excessive losses or price manipulation, exchanges install circuit breakers that stop trading in a stock or index if its price rises or falls beyond a certain limit.
There are two types of circuit breakers: upper circuit and lower circuit. The difference between the upper circuit and lower circuit is called the price band.
We will now discuss the upper and lower circuit breakers in stock markets in detail.
What is the upper circuit?
The upper circuit is the maximum level upto which a stock’s price or an index’s value can increase during a trading day. This refers to situations where there are more buyers who are ready to buy the stock at higher prices than sellers, causing the price to reach its upper limit.
The upper circuit level is calculated (or determined) based on the previous day’s closing price. Its value varies from stock to stock and the price band for the upper circuit can be anywhere between 2% to 20%.
It is important to note that a stock’s price cannot exceed its upper circuit during a single trading session. However, it is possible for the price to decrease if there is an increase in selling pressure.
Let us understand how this can happen. At the upper circuit level, generally, there are no sellers available. Still, if an investor with huge holdings of that particular stock decides to sell near the upper circuit level, then supply demand will shift, and prices can go down.
What is the lower circuit?
The lower circuit is the lowest level to which a stock’s price or an index’s value can fall in a single trading session. Stocks that many want to sell but only some or no people are buying might hit the lower circuit.
Lower circuit, just like the upper circuit, is also calculated based on the previous day’s closing price, and it may differ from stock to stock. The lower circuit value varies from stock to stock and the range for lower circuit can be anywhere between 2% to 20%.
A stock’s price is restricted from falling below its lower circuit during a single trading session. However, the stock’s price may increase if there is an influx of buyers.
Let us understand how this can happen. At the lower circuit level, generally, there are no buyers available. Still, if an investor with an interest in that particular stock decides to buy near a lower circuit level, then supply demand will shift, and prices can go up again.
Why do stocks hit upper or lower circuits?
In order to find out why stocks may hit their upper or lower circuit levels, let us examine a few cases
When a stock hits its upper circuit level
Assume that a listed pharma company creates a new drug that is more effective than the previously available drugs. This will cause a sudden surge in demand for its stock as it is bound to get more market share in the near future.
In such a scenario, the company’s existing shareholders are unlikely to sell their stocks, but potential buyers may bid higher prices. Upper circuit limit curbs this price surge within a day, protecting investors from excessive speculation and volatility.
Stocks may also hit their upper circuit levels due to pump-and-dump schemes.
In pump and dump schemes, manipulators buy heavy quantities of a stock at market prices, continuously making it hit upper circuit levels. After other investors also start showing interest in the stock, these manipulators start offloading shares held by them.
When a stock hits its lower circuit level
Let’s take a scenario about a company that is engaged in illegal business practices and the government is anticipated to take action against the company. The stocks of this company will become undesirable and everyone would try to sell their holdings. But since nobody is interested in buying them, existing shareholders will find it challenging to sell their shares.
When no one is interested in buying a stock, its price may decline. The apprehension of investing in a stock that is already falling could lead to a further decrease in the stock price. To avoid this scenario, lower circuits are established.
How to find out the lower and upper circuit for a stock?
In order to find out the lower and upper circuit of any stock you can go to the website of NSE and BSE and search for the stock in the search bar and find out the upper circuit and lower circuit levels of stock for that particular day.
For example, the stock of Relaxo closed at a price of 815.05 on 14th April and has a price band of 20%. So accordingly, its upper circuit price or upper band is (815.05 + 20% of 815.05) = 978.05. Similarly, the lower circuit price or lower band is 815.05 – 20% of 815.05) = 652.05
Factors that can lead a stock to hit circuit limits
As you are aware that markets work on the principle of supply and demand where sellers provide the supply of stocks and the buyers provide the demand for the stock.
In principle, any event that alters the appeal of a stock by an increase in its demand or an increase in its supply will result in the movement of its price. However, the change in the appeal must be substantial for the price levels to hit the upper or lower circuit.
Let us see some examples of events which can cause this
Events that may lead a stock to hit upper or lower circuit:
- Underperformance or outperformance in earnings
- Uncertainty in political environment
- Geopolitical issues like war, embargo, etc
- Fall or rise in foreign markets leading to change in investor confidence
- Change in central bank interest rates
- Fiscal expansion or consolidation
- Change in trade treaties or taxes (trade agreements, economic zones, tariffs, etc.)
- Underperformance or overperformance by competitors.
What are market-wide circuit breakers?
Market-wide circuit breakers are circuit limits linked to benchmark indices. When these limits are triggered all equity and equity derivative markets are simultaneously halted.
Both the NSE and BSE have circuit breakers that pause trading at three levels of their index’s movement. Following each halt, the NSE and BSE resume with a pre-opening session.
On March 13th, 2020, the Nifty 50 index dropped by 10% during early trading, leading to a 45-minute halt on the NSE and BSE.
Market-wide Circuit Breaker On NSE and BSE
What is the Dynamic price band?
Stocks which also have derivative contracts i.e Futures & Options (F&O) do not have predetermined circuit limits for the day, but have a dynamic price band of 10% instead on either side of the current market price to ensure that trading takes place within this specified range.
As the price approaches these levels, the limits are relaxed further to facilitate trading. Moreover, there is a cooling period of 15 minutes before new limits are added for F&O stocks. So indirectly we can say that F&O stocks don’t have a maximum upper or lower circuit limit.
Circuit limits are essential to protect investors from excessive speculation and market instability. The important thing is that a stock’s price usually hits its circuit limits only if there is a significant change in its demand or supply. Having said that, investors should be aware of market manipulators who may try to influence the demand and supply of stocks and be cautious and avoid making trades solely based on a stock or index hitting its upper or lower circuits.
Yes, you can easily sell shares at the upper circuit since many buyers are willing to buy shares.
No, during an upper circuit, there are no sellers available to buy stocks from hence it is not possible to buy stocks during the upper circuit.
The length of a halt in India is determined by the degree of variation in the index value and the moment the index reaches that value. Earlier in this article, we discussed the specifics of market-wide circuit breakers in India. However, there is no fixed duration for the circuit to end when it comes to stocks.
The Securities and Exchanges Board of India (SEBI) sets the circuit filters, which is then followed by exchanges.
No. For F&O stocks there are no circuit limits applicable, but instead, a dynamic price band of 10% on either side (lower or upper) is placed by the exchange. This price band gets revised after 15 minutes with an increment of 5% once upper or lower levels of the price band are reached. So the price band will be 10%,15%,20% and so on, on the lower or upper side.