Circuit Breaker Rules

Circuit Breaker Rules in the Stock Market

7 min read

Circuit breaker rules in the stock market keep things in order regarding panic selling. Most people are aware of electric circuit breakers. They are designed to protect an electrical circuit from damage when there is an overcurrent or a short circuit. A similar type of safety device is implemented in the stock market. They can be applied to the market as a whole or individual securities. The latter are separated into two tiers. We will take a deeper dive in the first three sections. In the last part of the article, we will explore previous examples of when circuit breakers were implemented. 

Circuit Breaker Rules TD

TD Ameritrade Website

In the US, regulators established three levels of market-wide circuit breakers. Over the last decades, they have been revised several times to establish the best possible responses to a market-wide sell-out.

There used to be three distinct levels of losses set at 10%, 20%, and 30%. At the beginning of every month, they were reset. Markets were halted when each level was reached. 

When investors see a stock they own begin to fall, they will most likely sell. On top of that, sell orders will also get triggered. Unless there is a halt to the selling, it can keep going indefinitely. To prevent this from happening, three levels of halts have been established.

They allow market participants to reset and hopefully reduce volatility and promote buying. This also benefits investors without time to react to the news. Below are the three levels that are triggered for the entire market. It is based on the performance of the S&P index.

Level 1: When the S&P declines by 7%, trading is suspended for 15 minutes. Trading is not suspended if this happens after 3:25 PM ET.

Level 2: When the S&P declines by 13%, trading is again suspended for 15 minutes. Trading is not suspended if this happens after 3:25 PM ET.

Level 3: When the S&P declines by 20%, trading is suspended for the rest of the day. 

In the last section of the article, we will see previous examples of when circuit breaker rules were applied. Next on the list are individual securities. 

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1. Individual Securities Circuit Breakers

When stocks are halted for volatility reasons, the circuit breaker moderator is called the Limit Up-Limit Down (LULD) circuit breaker. Two tiers of securities exist, each with a daily upper and lower price limit where they can trade. 

Tier 1: Individual stocks that belong to the S&P 500 index, the Russell 1000 index, or the QQQ ETF. If the stock changes by more than 5% within 10 minutes and does not go below that limit within 15 seconds, it is halted for 10 minutes. In the last 25 minutes of trading, the limit becomes 10%.

Tier 2: Tier 2 stocks priced over $3 have looser restrictions. They can change by up to 10% in 10 minutes and by 20% in the last 25 minutes of trading before getting halted. 

Stocks priced between $0.75 and $3 can vary by up to 20% in 10 minutes and 40% in the last 25 minutes of trading before getting halted.

Finally, stocks priced below $0.75 can vary by the lesser of 75% or $0.15 in 10 minutes and by 150% (upper limit) or $0.30 in the last 25 minutes of trading before getting halted.

Please visit NASDAQ’s website for information on individual securities being halted with circuit breaker rules.

2. Futures Circuit Breaker Rules

Futures that are part of the CME Group also have circuit breaker rules. Overnight, the price limit is 7%. Once that level is reached, futures remain open and can only be traded until that price limit. There is also an hourly limit in place. If the futures contract moves by over 3.5% within one hour, it is halted for 2 minutes. 

During the day, futures are halted simultaneously with the entire market when the S&P’s limits are reached. 

3. Crude Oil Circuit Breakers

Slightly different circuit breaker rules apply for crude oil futures. During a rolling 60-minute period, there is a 2-minute halt if there is a 10% move. This is an example of a dynamic circuit breaker. 

Historical Use of Circuit Breakers

Now, it’s time to look at the US’s historical use of circuit breaker rules.

1. Black Monday 1987 

A circuit breaker was first introduced in the stock market after Black Monday, October 19th, 1987. Ironically, the rise of electronic trading and High-Frequency Trading (HFT) caused the crash. Large numbers of orders were processed. Ultimately, it caused a 22.6% record single-day drop. After this crash, Ronald Reagan appointed a committee to discuss possible actions to prevent such crashes. The following year, circuit breakers were introduced. They differed from today’s 7%, 13%, and 20% levels. Over the years, these circuit breakers have adapted to the changing market.

2. October 27th, 1997

Ten years after their adoption, circuit breakers were finally used. On October 27th, 1997, the DJIA reached the 350-point decline at 2:36 pm. This caused a first halt, which lasted 30 minutes. The stock market resumed at 3:06 pm but had to halt again at 3:30 pm. At that time, the 550-point decline was reached. All market activities were canceled for the rest of the day. The following day began in the red again but ended almost 5% higher. These events triggered a re-evaluation of circuit breakers. Instead of a decline measured in points, a percentage change was implemented. 

3. March 2020

Between 1997 and 2020, circuit breakers were only used during the crash in 2008. During March 2020, they were used on four separate occasions, March 9th, 12th, and 16th, within a few minutes from the market opening and on March 18th later in the day. Despite many new lows across various industries, circuit breakers were winners. They effectively halted a market sell-out and were potentially the cause of the market recovery. 

4. Meme Stocks 2021

Many stocks were halted every few weeks in January, February, and March of 2021. They were branded as meme stocks. In a matter of months, AMC Entertainment (NYSE: AMC), BlackBerry (NYSE: BB), and GameStop (NYSE: GME) had massive price movements, and daily volume levels more than doubled.

On a single day in May 2021, GameStop was halted on four separate occasions between 10:14 am and 10:35 am. The other companies saw similar events happen to their stocks in the first months of 2021.

These events aren’t very common but happen every once in a while. But if you know your circuit breaker rules, you’d know how to trade or avoid these stocks.

Final Thoughts: Circuit Breaker Rules

To conclude, stock market circuit breaker rules are relatively recent in the stock market’s history. They were first introduced after the Black Monday crash in 1987. Since they have only been implemented a handful of times on the market, it is for the best. Investors don’t want to see many days where their portfolio loses between 7% and 20%.

Circuit breakers can also apply to stocks and futures. When these events happen, it’s important to remain quiet. This is where sell-and-buy orders can come in handy.

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