What is market volatility?

What is a Circuit Breaker?

A circuit breaker in the stock market is a mechanism used to temporarily halt trading on an exchange to prevent panic-selling or a market collapse. When there is a significant drop in stock prices within a short period, circuit breakers are activated to provide a cooling-off period. Let’s dive deeper into how circuit breakers work and their importance in maintaining market stability.

1. What Triggers a Circuit Breaker?

Circuit breakers are triggered when the market experiences a sharp decline in a short amount of time. Typically, this happens when stock indices such as the Sensex or Nifty drop by a certain percentage, like 10%, 15%, or 20%. These thresholds can vary based on the country and the exchange rules.

2. Types of Circuit Breakers

There are generally three types of circuit breakers based on the extent of the market decline:

• Level 1: A temporary halt in trading when the market falls by 10%. This lasts for 15 minutes.
• Level 2: A longer halt if the market drops by 15%. This lasts for 1 hour.
• Level 3: A complete suspension of trading if the market falls by 20%. This lasts for the rest of the day.

3. Purpose of a Circuit Breaker

The primary goal of a circuit breaker is to prevent extreme market volatility by giving investors time to evaluate market conditions and make informed decisions. It helps avoid panic selling, which can worsen a market crash and ensure smoother trading during periods of high uncertainty.

4. Benefits of Circuit Breakers

Circuit breakers serve several key purposes in the stock market:

• Market Stability: By limiting extreme fluctuations, circuit breakers help maintain market order and stability.
• Investor Protection: They provide investors time to reconsider their actions and prevent hasty, irrational decisions.
• Prevention of Market Panic: Circuit breakers help calm market sentiment during times of uncertainty, reducing the risk of a full-blown market crash.

5. Conclusion

Circuit breakers are an essential tool for maintaining stability in the stock market during periods of sudden volatility. By temporarily halting trading, they give investors time to process information, reducing the chances of knee-jerk reactions. While circuit breakers can’t prevent market crashes, they play a crucial role in helping markets recover more smoothly.