What is Upper Circuit and Lower Circuit in Share Market? We Explain.

Upper Circuit and Lower Circuit in Stock Market: Introduction

It would not be hasty to claim that India has entered its fresh phase of investing with the inclination of the younger generation to the world of stocks. On that one note, the country has witnessed an altogether different wave in the Indian stock market. However, first-time investors are bound to get anxious with fancy jargon like upper/lower circuits, especially due to the half-witted knowledge available on the topic in the market. 

The said subject is not rocket science, however, it requires a thorough understanding by the investors before making some viable decisions. Certainly, by the end of this article, you should be able to gauge the required information on what the circuit filters are, why they are applied, who applies them and what you should do to not fall into the circuit trap. 

Summary in brief

• What are upper and lower circuits?
• What drives the upper/lower circuit?
• Market Circuit Breakers-Triggering point and halt time
• What should an investor do?
• FAQs

What are upper and lower circuits?

With the shares plummeting the circuits all way long since the start of 2022, it shall not be a surprise if we label this year as the official circuit-breaker year. And that brings us to the very question of what is an upper circuit and a lower circuit in the share market?

Well, it is said that the Indian stock market runs more on emotions and less on the fundamentals. On a different note, the stock market is a hub of varied minds that includes retail investors, mutual funds, institutional buyers, experts, people who invest with their instincts, people who invest on what other people invest in etc. This is likely to bring down the predictability of the market. And with the emotional response to the market sometimes it is bound to create erratic price movements. 

To control the market imbalance caused by the volatility of price, circuits or limits in the form of the upper circuit and lower circuits are applied to particular stocks or indices. When these circuits are active or triggered, trading in the stock market for that particular stock/indices is put to a halt. This is done to curb the extreme price fluctuation that may be happening due to panic buying/selling of that stock. 

The stocks hit a high price point when there is a huge line of buyers (high demand) but almost no sellers for the stock (low supply), this causes the price to shoot up than expected and hence to tackle the situation market watchdog has created the concept of the upper circuit. So now when the stock hits the upper circuit, the price point of that stock cannot move above that point i.e. it has reached its maximum level for that particular trading session. 

The lower circuit follows the same philosophy except, for lower circuit stocks, there exist several sellers but no buyers. And it is the maximum level beyond which the price of a stock/indices cannot fall.

What drives the upper/lower circuit?

The most fundamental driver that leads a company to reach a point of upper/lower circuit is the forces of demand and supply. However, these forces are also affected by several factors that may lead a stock/index to hit its maximum high/low price points. Some of these factors are:

• Change in the structure of the organization- Mergers, and Acquisitions
• Political Disturbance
• Changes in trade agreements
• Changes in interest rates such as repo rate, reverse repo rate, etc
• Company's  Financial Performance
• Expansions, insolvency, consolidations
• Investor confidence

Market Circuit Breakers-Triggering Point and Halt Time

The Indian stock market follows a coordinated halt time in all the equity and derivative markets. This is done when the market circuit breakers are triggered i.e. the upper circuit and lower circuit. The circuit breaker's halt is carried out in 3 stages of both the BSE AND NSE index movements.

After each halt session, BSE reopens the market with a pre-opening session while 

NSE reopens the market with a pre-open call auction session.

Also, note that the duration of this halt is decided by the Securities Board Exchange of India based on the percentage of price movements. For individual stocks, the circuit percentage is based on the direction of the price movement of the stock and its category. For index-based market-wide filters, the percentages are 10%, 15% and 20%.

The basic overview of the circuit trigger point and the action halt time can be best represented by the table below:

To understand the above table more clearly. Let us take an example

When a stock let's say X Green was marked at let's say ₹1000 in the Indian stock market as per the previous close. Now in the current trading day, the price of this suddenly started soaring high due to a rush to buy this stock in the market. This leads to the application of let's say a circuit filter of 20%. In this case, if the price rises to ₹1200 or falls to ₹800, the circuit breakers shall be triggered and the respective halt period as per the time frame shall be applied to this stock.

This was the case for an individual stock but when it comes to the market index, the approach is slightly different.

In the case of indices such as BSE Sensex or the NIFTY 50 index, these circuit breakers are based on the points at which the respective index was closed on the previous trading day. For example, if the Sensex closed on 20,000 points on the previous trading day a fall to or beyond 18000 points, 17000 points, or 16000 points or a rise to or beyond 22000 points, 23000 points or 24000 points shall trigger the circuit breaker. This shall lead to a market-wide halt session as per the mentioned time frames.

What Should an Investor Do?

It is of utmost importance for an investor to understand that these circuit breakers are applied to protect their interest. Securities Exchange Board of India (SEBI) has been working explicitly to safeguard investors from market manipulations. Applying circuit breakers is one such step towards shams like price rigging and market domination.

For real-time investors, it is advisable to not fall into the trap of herd mentality while investing in stock and rather invest with due diligence by understanding the company’s financial position and acquiring basic knowledge of the working of the Indian stock market.