Understanding Upper and Lower Circuit in Trading

What are Circuit Breakers?

 

Circuit breakers are mechanisms meant to stop excessive price swings in stocks or indexes inside one trading session. They serve as safety nets to prevent market exuberance or panic from driving illogical pricing movements. Depending on the circumstances, trade is either temporarily stopped or totally stopped when the price of a stock or index approaches a predefined level. We call these thresholds higher and lower circuits.

 

The Upper Circuit

The upper circuit, set by the stock exchange, is a pricing limit beyond which a stock cannot rise in one trading session. Trading in a stock that reaches its upper circuit stops for a designated period or occasionally for the whole trading day. This helps to stop too much speculation and provides investors with time to reconsider the value of the stock.

Example:

Say a stock is trading at ₹100, and the stock exchange has set a 10% upper circuit limit. Should the stock price hit ₹110, the higher circuit is set off, therefore stopping trading in that stock. Until the circuit is raised, the stock's price cannot rise higher anymore.

 

The Lower Circuit

On the other hand, the lower circuit represents a pricing restriction beyond which a stock cannot drop within one trading session. Trading is likewise stopped when a stock reaches its lower circuit to stop panic selling and provide investors with an opportunity to review the circumstances.

Example:

Think about the identical stock trading for ₹100 with a 10% lower circuit limit. Should the stock price drop to ₹90, the lower circuit is set off, therefore stopping trade in that stock. Until the circuit is raised, the stock's price cannot be any lower.

 

How Are Circuit Limits Determined?

The stock exchanges impose circuit restrictions, which vary based on the stock or index. Based on historical volatility and trading volume, the circuit restrictions for particular equities could run from 2% to 20%. Generally speaking, circuit restrictions for indices are 10%, 15%, and 20%. Should an index exceed any one of these thresholds, trading across the whole market may be stopped.

 

Why Are Circuits Important?

The protection of investors and the stability of the market depends on both upper and lower circuits. Here's why:

 

Preventing Market Manipulation:

Circuits avoid market manipulation by restricting the degree to which a stock's price might be artificially raised or lowered within a single trading session.

 

Reducing Panic and Speculation:

Circuits provide a cooling-off interval in times of great market volatility, enabling investors to make more educated decisions rather than being driven by fear or greed.

 

Ensuring Fair Trading:

Stock exchanges guarantee that all investors have equal access to information and can make judgments depending on a more logical evaluation of the market by stopping trade when circuits are triggered.

 

Impact on Traders

Effective trading for traders depends on a knowledge of upper and lower circuits. Their influence on trading techniques follows this:

 

Liquidity Concerns:

Trading stops when a stock reaches its upper or lower circuit, momentarily losing liquidity. Traders seeking to enter or leave a position could discover they are restricted until the circuit is lifted.

 

Strategy Adjustments:

Traders must change their plans to consider the likelihood of circuit triggering. This could call for tightening stop-loss orders, avoiding extremely erratic equities, or becoming ready for abrupt trading pauses.

 

Market Sentiment:

A circuit's turning on also marks a change in market mood. An upper circuit, for instance, would show a strong bullish attitude, whereas a lower circuit would indicate a bearish attitude. This data helps traders assess the general attitude of the market.

 

Conclusion

In trading, upper and lower circuits are essential systems that provide market stability and shield investors against great volatility. Knowing how these circuits operate helps traders negotiate the market, make wise judgements, and safeguard their money. Successful trading depends on monitoring circuit restrictions and knowing their consequences regardless of your level of experience with trading.

AlmondzTrade, india’s reliable stock broking platform, is here to help you reach your financial objectives and provide new ideas and professional direction on trading techniques. Our knowledgeable staff offers comprehensive tools and assistance to assist you in understanding the complexity of the market, including knowledge of how circuit breakers affect your trading decisions.