Circuit limits are pre-defined price thresholds that are set by the stock exchange to restrict the maximum and minimum price movements of individual stocks or the broader market during a trading session. These limits are designed to prevent excessive price volatility and promote fair trading opportunities for investors to transact at reasonable prices. In this blog, we will explain why do we need circuit limits, what are the different circuit limits, how do circuit limits work and how you can make profits with circuit limits.
Why do we need Circuit Limits?
Quis Ipsos Ipsos Custodios!
Who guards the Guards?
Let’s break a misconception before we break a leg in the stock market.
Stock Market has no checks or regulation to keep stock prices in place.
This is where SEBI weighs in.
Every country has a regulatory authority and in India, SEBI regulates the stock market.
SEBI sets two limits – the upper circuit and the lower circuit to stop too much volatility in stocks.
Upper Circuit Limit
The stock exchange sets a price limit called the upper circuit, which restricts the maximum price a stock can reach during a trading session. This measure aims to prevent excessive price fluctuations and promotes fair trading opportunities for buyers and sellers to transact at a reasonable price. If a stock reaches its upper circuit limit, it becomes “locked in” or “frozen” at that price for some time or the rest of the trading session.
Lower Circuit Limit
To safeguard investors from sudden and significant drops in the value of their investments, the lower circuit is a price limit imposed on individual stocks or the entire market. This measure is intended to curb excessive price fluctuations and serves as the opposite of the upper circuit, which restricts stocks from experiencing rapid price surges.
More on Circuit Limits:
This limit is usually 5%,or 10%, or 20% of the previous day’s closing price.
Example:
For example, if the CMP – Current Market Price of a company’s stock is Rs. 100,
It can move upward or downward by a maximum of 20% in a single trading day.
ie 20% of 100 = 20 + 100 = Rs 120 which is the upper circuit for it.
Similarly, i.e 20% of 100 = 100 – 20 = Rs 80 would be the lower circuit for it.
When the stock hits the circuit, stock stops at the circuit price and trading is halted so that investors don’t suffer from panic buying and selling.
Imagine this as the deep breath and a glass of water you take before an exam. The stock market enables a breathing space for traders to decide better.
What should you do when your stock hits the upper circuit?
During the course of day, if Stock Price > or < than Circuit Limit,
Trading is Halted upto 1 Hour 45 minutes if Circuit Limit < 20%
Trading is Halted for the rest of the day if Circuit Limit is > 20%.
The Halt Time window varies based on exact time during market hours.
These conditions include 1 PM, 2.30PM and what happens after 2.30 PM.
When a stock hits an upper circuit, there will be only buyers and no sellers.
Similarly, when a stock hits a lower circuit, there will be only sellers and no buyers.
What should you do when your stock hits the upper circuit?
Buy! Place a Buy order.
What should you do when your stock hits the Lower circuit?
Sell & Exit! Place a Sell order as soon as you can and exit from the stock.
What happens when the stock hits lower circuit?
ABC is trading at a stock price of Rs.500. It hits the lower circuit at Rs.450. Market halts and reopens with a new price, say Rs.460.
How to exit from Lower circuit stock?
Let’s learn how to exit from lower circuit-making stocks.
During the circuit break market the market works on the first come first serve basis. This means that placing the order at the earliest might help you in selling the stock and prevent or reduce loss.
Hence, the most guaranteed way of selling a lower circuit is to place an order during the pre-open session before the market opens up. It’s after this session that order gets executed.
Lower Circuit NSE:
Sell Share Price = ( Current Market Price * 0.95 ) + 0.05(optional)
How to enter into Upper circuit stock?
Let’s learn how to enter into upper circuit-making stocks.
Sell Share Price = (Current Market Price * 1.05) – 0.05.
If the circuit limit is 5%, there is a probability that you may buy spending more price if you do not subtract 0.05.
Circuit Limit Vs Stop Loss
Most investors get confused with the terms circuit limit and stop loss.
Stop Loss is what “YOU” set to buy or sell your stock at a price at which “YOU” want to sell your stock.
Circuit Limit is set by SEBI in India. Circuit Limit is set by regulator or the exchange globally.
Impact of Circuit Limit on Scalping Trading Strategy:
Upper and lower circuits can have an impact on scalping trading. As this can limit the price movements of a stock, making it more difficult for scalpers to profit from small price movements. When a stock hits the upper or lower circuit limit, it can be difficult to buy or sell the stock at the desired price. This is because trading at circuit can make scalping less effective. As a result, scalpers may need to adjust their trading strategies to account for the impact of circuit limits on the market. Read our blog on Scalping to know more about this Trading Strategy.
Why Circuits Break?
Positive News – Upper Circuit
Negative News – Lower Circuit
The stock market is a dynamic and constantly changing environment, where prices can fluctuate rapidly based on a range of factors. In order to prevent extreme price volatility and promote fair trading practices, stock exchanges around the world implement a range of price limits and trading restrictions. One of the most important of these is the upper circuit, which is a price limit that prevents a stock’s price from rising beyond a certain level during a trading session.
What is the Upper Circuit in the Stock Market?
The upper circuit is a price limit that is set by the stock exchange beyond which a stock’s price cannot rise during a trading session. This limit is put in place to prevent excessive price volatility and to ensure that buyers and sellers have a fair opportunity to transact at a reasonable price. When a stock reaches its upper circuit limit, it is said to be “locked in” or “frozen” at that price for the remainder of the trading session.
The upper circuit limit is usually expressed as a percentage of the stock’s previous day’s closing price.
For example, if a stock’s closing price on Day 1 was Rs. 100, the upper circuit limit for Day 2 might be set at Rs. 120, which represents a 20% increase over the previous day’s closing price.
If the stock’s price reaches Rs. 120 during trading on Day 2, it will be locked in at that price for the rest of the trading session.
How Does the Upper Circuit Work?
The upper circuit works by setting a maximum price limit for a stock during a trading session. When a stock’s price reaches this limit, it is “locked in” or “frozen” at that price, meaning that it cannot rise any further for the rest of the session. This prevents excessive price volatility and ensures that buyers and sellers have a fair opportunity to transact at a reasonable price.
The upper circuit limit is usually set as a percentage of the stock’s previous day’s closing price. The percentage limit can vary depending on the stock, the exchange, and the prevailing market conditions. In India, for example, the upper circuit limit is usually set at 20% of the previous day’s closing price. In the United States, the upper circuit limit for individual stocks is generally set at 5% or 10%, depending on the exchange.
If a stock’s price reaches its upper circuit limit early in the trading session, it can sometimes remain locked in at that price for the rest of the day. This can lead to a situation where there is no trading activity in the stock for the remainder of the session, as buyers and sellers are unable to transact at a different price.
What Are the Benefits of the Upper Circuit?
The upper circuit provides several benefits for investors and traders. First, it prevents excessive price volatility and ensures that prices remain within a reasonable range. This can help to reduce the risk of sudden and dramatic price movements that can be difficult for investors to manage.
Second, the upper circuit promotes fair trading practices by ensuring that buyers and sellers have a fair opportunity to transact at a reasonable price. When a stock’s price is locked in at the upper circuit limit, buyers and sellers can transact with confidence, knowing that they are getting a fair price.
Finally, the upper circuit can help to maintain investor confidence in the stock market by reducing the risk of sudden and extreme price movements. When investors have confidence in the market, they are more likely to invest, which can help to stimulate economic growth and create jobs.
What Are the Limitations of the Upper Circuit?
While the upper circuit provides several benefits, it also has some limitations that investors and traders should be aware of. Here are some of the key limitations of the upper circuit:
First, the upper circuit can sometimes lead to a situation where there is no trading activity in a particular stock for the day.
Reduced liquidity:
The upper circuit can sometimes lead to a situation where there is no trading activity in a particular stock for the day. This can occur when a stock reaches its upper circuit limit early in the trading session and remains locked in at that price for the rest of the day, with no opportunity for buyers and sellers to trade at a different price. This can reduce liquidity in the market and make it more difficult for investors to buy or sell shares.
Market inefficiencies:
The upper circuit can sometimes create inefficiencies in the market by preventing prices from adjusting to changing market conditions.
For example,
If a stock is experiencing strong demand and its price is rising rapidly, the upper circuit may prevent the price from rising further, even though there is still strong demand from buyers. This can lead to a situation where the stock’s price does not reflect its true value.
Limited price discovery:
The upper circuit can limit the ability of the market to discover the true price of a stock. When a stock is locked in at its upper circuit limit, buyers and sellers are unable to transact at a price that reflects the true supply and demand for the stock. This can limit the market’s ability to accurately price the stock and can lead to distortions in the market.
Manipulation:
The upper circuit can sometimes be manipulated by unscrupulous traders who seek to artificially inflate the price of a stock. By buying up large quantities of a stock and pushing its price up to the upper circuit limit, these traders can create the appearance of strong demand for the stock, even if there is little genuine interest from buyers. This can lead to a situation where the stock is overvalued and investors are misled about its true value.
Risk of flash crashes:
The upper circuit can increase the risk of flash crashes in the market. Flash crashes occur when there is a sudden and dramatic decline in the price of a stock or the broader market.
When a stock is locked in at its upper circuit limit, there is a greater risk of a flash crash occurring if market conditions suddenly shift and buyers suddenly become less interested in the stock.
The upper circuit is a price limit that is put in place to prevent excessive price volatility and ensure that buyers and sellers have a fair opportunity to transact at a reasonable price. While the upper circuit provides several benefits, it also has some limitations that investors and traders should be aware of, including reduced liquidity, market inefficiencies, limited price discovery, manipulation, and the risk of flash crashes.
Lower Circuit:
The lower circuit is a price limit that is applied to individual stocks or the broader market to prevent excessive price volatility and to protect investors from sudden, dramatic declines in the value of their investments. It is the opposite of the upper circuit, which is a price limit that prevents stocks from rising too rapidly.
When a stock or the broader market reaches its lower circuit limit, trading is temporarily halted. This gives investors and traders time to digest new information, adjust their strategies, and reassess their positions. Once the trading halt is lifted, trading can resume, but only at or above the lower circuit limit.
The lower circuit is typically calculated as a percentage of the stock or index’s previous closing price. The exact percentage varies depending on the stock or index in question, as well as market conditions and regulatory requirements.
For example,
Some stocks may have a lower circuit limit of 5%, while others may have a limit of 10% or more.
The lower circuit is triggered when a stock falls in significant value over a short period of time.
For example,
If a stock’s price drops by more than the lower circuit percentage within a few minutes or hours of trading. Then, the lower circuit may be triggered and trading in that stock may be halted.
The purpose of the lower circuit is to prevent panic selling and to provide a stabilizing force in the market.
By temporarily halting trading,
The lower circuit gives investors and traders time to
- Absorb new information,
- Adjust their strategies,
- Reassess their positions.
This can prevent a sudden, dramatic decline in the value of a stock or index. Dramatic declines can be harmful to investors and can have broader economic consequences.
Lower Circuit – Benefits:
Protecting investors:
The lower circuit provides a safety net for investors, protecting them from sudden, dramatic declines in the value of their investments. By halting trading and preventing panic selling, the lower circuit can help to stabilize the market and prevent investors from making hasty decisions that they may later regret.
Reducing volatility:
The lower circuit can help to reduce price volatility in the market by preventing stocks or indices from experiencing rapid, sharp declines in value. By limiting the rate at which prices can fall, the lower circuit can provide a stabilizing force in the market and prevent wild swings in prices.
Encouraging long-term investing:
The lower circuit can encourage investors to take a long-term view of the market.
How?
By preventing short-term fluctuations from dominating market movements.
By providing a safety net for investors, the lower circuit can help to foster a more stable investment environment.
Lower Circuit – Limitations
When trading is halted due to the lower circuit,
Investors may not be able to buy or sell shares until trading resumes. This can lead to a lack of liquidity in the market, which can cause additional volatility when trading resumes.
It may not prevent significant losses:
While the lower circuit can help prevent steep declines in a stock’s price, it may not be effective in all cases. If the market is experiencing a significant downturn, the lower circuit may not be enough to prevent large losses for investors.
It can be manipulated:
In some cases, traders may try to manipulate the market by artificially causing a stock’s price to hit the lower circuit. This can be done by selling large amounts of the stock in a short period of time. This can trigger the lower circuit and lead to a temporary halt in trading.
It can create information asymmetry:
When trading is halted due to the lower circuit, some investors may have access to information that others do not.
For example,
If a company announces a negative earnings report after trading has been halted,
Some investors may be able to act on that information before trading resumes, potentially leading to unfair advantages.
