Circuit Breaker

Definition

A Circuit Breaker is an emergency regulatory measure to temporarily halt trading on an exchange. * It is designed to curb panic-selling and restore order during periods of extreme volatility. * Just like an electrical circuit breaker cuts off power to prevent a fire, this cuts off trading to prevent a market meltdown.

Triggers (US Market)

In the US, market-wide circuit breakers are triggered by declines in the S&P 500 Index relative to the previous day's close. * Level 1 (7% Drop): Trading halts for 15 minutes. * Level 2 (13% Drop): Trading halts for 15 minutes. * Level 3 (20% Drop): Trading is suspended for the remainder of the day.

Why is it needed?

• Origin: Introduced after the Black Monday crash of 1987, where the Dow fell 22.6% in a single day with no mechanism to stop the bleeding.
• Psychology: It forces a "time-out." This allows algorithmic trading programs to reset and gives human traders a moment to assess whether the drop is driven by fundamentals or pure fear.

Individual Stock Halts (LULD)

While "Circuit Breakers" usually refer to the whole market, individual stocks have their own safety mechanism called LULD (Limit Up-Limit Down). * If a single stock moves too quickly (e.g., >10% in 5 minutes), trading on that specific stock is paused for 5 minutes.