Stock markets are known for their volatile nature, where sudden price swings can impact investors. To safeguard their interests, SEBI introduced upper and lower circuits that set maximum and minimum price levels within a single trading session. This ensures that a stock’s price cannot rise beyond its upper circuit or drop below its lower circuit in one day, effectively managing extreme fluctuations.

An upper circuit is the maximum percentage rise allowed to a stock’s price within a single trading session. When the limit is achieved, trading in that particular stock is suspended for some time to prevent investors from continuously buying the stock at inflated prices, thus avoiding a market bubble.

On the other hand, a lower circuit is the maximum percentage drop that can occur within a single session in which stock prices decline. The moment this limit is triggered, trading in the shares is also stopped to prevent the sale by investors at depressed prices and minimise the risk of a market crash.

These circuits are based on the previous closing price of a stock, with percentage limits set by the stock exchange. These limits vary for each stock and are designed by SEBI to maintain market stability.

Investors should consider circuit filters in their decisions. If a stock is near its upper circuit, buying may not be ideal due to a higher chance of price correction. Likewise, selling near the lower circuit may not be wise, as prices could rebound.

Understanding Upper and Lower Circuit Limits for Stocks

To provide better protection to investors against rapid fluctuations in the price of a given stock within a single trading session, stock exchanges set a price band for every stock depending on its last traded price. These bands are called upper and lower circuits.

Actually, the purpose of these price bands is to protect investors from market shocks. Among the causes of such changes in the stock value are news, events, or even emotions, and in the absence of circuit filters, investors would act impulsively and create either a bubble or a crash in the market.

These circuit filters ensure that greater equity market stability is attained, whereby investors are able to take positions based on the prevailing market conditions without the risk of abrupt price changes.

Understanding Upper and Lower Circuit Limits for Indices

There is a limit for the upper and lower circuits on stock indices in the Indian stock market, too, but those limits are the same as for individual stocks.

In other words, a stock index is a benchmark reflecting the general performance of a certain stock group within a particular market. Major Indian stock indices include BSE Sensex and NSE Nifty 50.

A circuit breaker is triggered in India when the index rises or falls by 10%, 15%, or 20%. If a 10% movement occurs after 2:30 PM, trading continues due to typically higher volatility at the end of the day. If it happens between 1 PM and 2:30 PM, trading halts for 15 minutes. If before 1 PM, trading is suspended for 45 minutes.

For a 15% movement, trading stops for the rest of the day if it occurs after 2:30 PM. If it happens between 1 PM and 2:30 PM, trading halts for 45 minutes, and before 1 PM, it’s suspended for 1 hour and 45 minutes.

If the index moves by 20% at any time during the trading day, trading is suspended for the remainder of the day. This circuit breaker system aims to prevent extreme volatility, protect investors from significant losses, and allow time for reassessing positions.

Factors Driving Upper and Lower Circuit Limits:

Mergers and Acquisitions: Two merging firms raise the potential expectation to improve their financial performance, meaning an increased demand for their common stocks. An acquisition, however, may burden the acquired firm with debts, lowering the demand for its common stock.

Political Disturbances: When the firm experiences unrest or instability due to political movements, investor confidence falls about its ability to perform and causes the prices of common stocks to decline. Political stability and policies become desirable in enhancing investor’s confidence that pushes prices up.

Trade Accords: Trade agreements, which are favourable, enhance the demand for the shares of the affected companies. Unfavourable trade accord reduces demand.

Interest Rates: High interest rate hurts borrowing and investment, and so hurts the stock price. Conversely, low interest rate boosts both borrowing and investments and can help push up the stock price.

Financial Performance: A company enjoying good financial performance will attract investors. This leads to an increase in the demand of a company’s stock. Poor financial performance works like a disincentive for investors to invest, thereby, decreasing the demand of the company’s stocks.

Expansions, Insolvencies, and Consolidations: Expansion news can create expectations of higher future revenues, increasing demand for the stock. An announcement of insolvency or consolidation will likely send stock prices downwards since it indicates lower future revenues.

Investor Confidence: Positive news can also build confidence into investors’ minds and cause an increase in the price of the stock, whereas any bad news would erode confidence and bring the price crashing down.

What Happens When Circuit Limits Are Hit?

When a stock hits its upper circuit, its price has reached the maximum increase allowed for the day, resulting in only buyers with no sellers available.

Conversely, when a stock hits its lower circuit, its price has fallen to the maximum decrease allowed for the day, leading to only sellers with no buyers.

Intraday trades are converted to delivery trades when an upper or lower circuit is triggered. This occurs because trading in that stock is halted for the remainder of the day, and the only option left is through delivery.

Frequently Asked Questions (FAQs)

What are circuit limits?

Price bands set by stock exchanges to prevent extreme fluctuations in stock prices.

What happens at the upper circuit?

The stock price reaches its maximum daily increase, leading to only buyers and no sellers, with trading temporarily halted.

What happens at the lower circuit?

The stock price falls to its maximum daily decrease, resulting in only sellers and no buyers, with trading also halted.

How do circuit limits affect intraday trades?

Intraday trades convert to delivery trades when a circuit limit is hit, as trading in that stock is paused.

What drives changes in circuit limits?

Factors include mergers, political events, trade agreements, interest rates, and investor confidence.

How can investors benefit?

Understanding circuit limits helps investors make informed decisions and identify trading opportunities.

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