What is circuit breaker in the stock market

In the stock market, a circuit breaker is a mechanism designed to halt trading in a particular stock, index, or market segment when it experiences a significant price drop or volatility surge. The purpose of a circuit breaker is to prevent a market meltdown or a rapid decline in prices, which can lead to investor panic and further market instability.

There are two types of circuit breakers:

  1. Single-stock circuit breaker: This type of circuit breaker is triggered when a specific stock's price falls by a certain percentage (usually 10-15%) within a short period (usually 5-15 minutes). Trading in that stock is halted until the price recovers or the circuit breaker is reset.
  2. Index-based circuit breaker: This type of circuit breaker is triggered when a major stock market index (e.g., S&P 500, Dow Jones Industrial Average) falls by a certain percentage (usually 7-10%) within a short period (usually 15-30 minutes). Trading in all stocks within that index is halted until the index recovers or the circuit breaker is reset.

Circuit breakers are designed to:

  1. Prevent panic selling: By halting trading, circuit breakers prevent a rapid decline in prices, which can lead to a self-reinforcing cycle of selling and further price drops.
  2. Stabilize the market: Circuit breakers help to restore order to the market by giving investors time to reassess their positions and allowing market makers to adjust their quotes.
  3. Protect investors: By limiting the potential losses, circuit breakers help to protect investors from significant losses due to market volatility.

Examples of circuit breakers in action:

Circuit breakers are typically implemented by stock exchanges, such as the New York Stock Exchange (NYSE) or the NASDAQ, and are designed to be triggered by specific market conditions.