Stock market circuit breakers are used to temporarily stop the trading of all securities in the event of rapid, steep downturns in broad market pricing. Circuit breakers trigger automatically on every U.S. stock and futures exchange when the S&P 500 Index drops by specified amounts during a single trading session. The first circuit breaker trips when the index falls by at 7% compared to the previos day’s close. The trading halt is intended to stop panic selling and to restore stability during severe market declines.
A financial advisor can help you create a financial plan to diversify your portfolio during inflation and market volatility.
How Circuit Breakers Work
Circuit breakers stop all trading in securities in across markets when prices experience sudden, unexpected and extreme declines. The idea is to keep investors from engaging in emotion-driven selling, which can drain the markets of liquidity and lead to even more drastic price declines.
Circuit breakers are triggered by declines in the value of the S&P 500 Index, which tracks the market value of 500 of the largest publicly traded U.S. companies. The current value of the index during the trading session is compared to the value of the index at the close of trading on the previous day. If the decline meets the threshold, the circuit breaker automatically activates.
The length of time trading will be stopped depends on how much the value of the S&P 500 index declines. There are three different set points:
- Level 1, a 7% decline in the index
- Level 2, a 13% decline
- Level 3, 20% decline
The effect also can depend on the time of day at which the level is reached. A Level 1 or Level 2 circuit breaker, if activated before 3:25 p.m., will stop all trading for 15 minutes. If a Level 1 or level 2 circuit breaker is reached at or after 3:25 p.m. trading is not halted and continues as normal.
Trading hours in most U.S. markets, including the New York Stock Exchange and NASDAQ, extend from 9:30 a.m. to 4 p.m. Eastern Time. This means that a Level 1 or Level 2 circuit breaker’s activation in the last five minutes of the session has no effect.
Also, there can be only one Level 1 or Level 2 breach during a single trading day. This means if a Level 1 break occurs and then the S&P 500 declines by another 7%, it won’t activate the circuit breaker. If the index drops by 13%, it would trigger a Level 2 break.
A Level 3 halt ends trading for the remainder of the trading day, no matter what time of day it occurs.
Resuming Trading After a Circuit Breaker
Typically, trading resumes as normal once a Level 1 or Level 2 15-minute break has expired or, if the halt is for the rest of the day, when the markets open again the next day. However, the individual exchanges can exercise discretion about re-starting trading. Trading may be delayed in some circumstances longer than 15 minutes.
In addition to affecting the equities market, the triggering of a circuit breaker also halts options trading on the exchanges.
Circuit Breaker History
The exchanges agreed to implement a circuit breaker after the October 1987 crash. This crash involved a one-day drop in the S&P 500 Index of 22.6%. That would have activated the Level 3 circuit breaker.
Circuit breakers next activated a decade later during the 1997 Asian financial crisis. That was the only time the circuit breakers came into action until 2020.
During the early months of the Covid pandemic, the circuit breakers tripped on March 9, 2020. That day, the S&P 500 Index dropped 7% during the first few minutes of trading, initiating a 15-minute halt. Circuit breakers came into action three more times during the same month.
Other trading stops have also occurred a few times throughout history. After the assassination of President Abraham Lincoln in 1865, exchanges halted trading for a week. Trading was held up again in 1873, for 10 days, to stem a panic that began in the market for railroad bonds.
The longest halt to trading took place in 1914 on the outbreak of World War I in Europe. Trading on the NYSE stopped for four months to prevent European holders of U.S. debt securities from selling off their portfolios to finance the war.
Circuit breakers stop all trading on exchanges when a broad-based measure of market valuation declines by a certain amount during a single trading session. The circuit breaker scheme adopted by U.S. exchanges has three different levels, corresponding to 7%, 13% and 20% drops in the value of the S&P 500 Index compared to the previous day’s closing value. When a circuit breaker trips, trading will halt for 15 minutes for the first and second level. A Level 3 event ends trading for the rest of the day.
Tips for Investing During Market Volatility
- A financial advisor can help you create a financial plan to minimize the impact of inflation and market volatility. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Inflation affects equities in three ways: Corporate profits, consumer spending and the overall economy. This guide will give you a fuller explanation and tips to respond to inflation as an investor.
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