Circuit Breaker (Investing)
The term circuit breaker refers to the policies and procedures that halt or stop trading when securities fall by a given percentage over a specified period of time. Circuit breakers were put into place by the Securities and Exchange Commission following the Stock Market Crash of 1987.
On October 19, 1987, also known as Black Monday, the Dow Jones would decline 508 points, losing 22% of its value in just a single day. Investors would also lose an estimated $500 billion in assets. The magnitude of the decline on Black Monday is attributed to a combination of panic selling by investors as well as program trading.
Several policies and procedures were introduced by the Securities and Exchange Commission (SEC) following their investigation into the events occurring on Black Monday. The most notable guideline is the circuit breaker concept, which halts trading under certain conditions to address volatility in the United States equities market. As of January 4, 2016, the circuit breaker rules included:
Limit Up Limit Down Mechanism
- Applies to an individual stock, and the price band is set at a percentage level above and below the average price of the stock over the preceding five-minutes.
- The price limit bands are 5%, 10%, 20%, or the lesser of $0.15 or 75%, depending on the price of the stock.
- The price band doubles during the opening and closing periods of the trading day.
- If the stock’s price does not move back into its price band within 15 seconds, there will be a five-minute trading pause.
Market-Wide Circuit Breaker
- A cross-market trading halt can be triggered at three circuit breaker thresholds, including declines of 7% (Level 1), 13% (Level 2), and 20% (Level 3). The triggers are determined using the closing price of the S&P 500 Index on the prior trading day.
- A market decline that triggers a Level 1 or Level 2 circuit breaker before 3:25 p.m. will halt market-wide trading for 15 minutes, while a similar market decline “at or after” 3:25 p.m. will not halt market-wide trading.
- A market decline that triggers a Level 3 circuit breaker will halt market-wide trading for the remainder of the day.